See Accompanying Notes to Consolidated Financial Statements.

Misonix, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

For the Three and Six Months Ended December 31, 2018 and 2017 and 2016 (unaudited)

1. Basis of Presentation, Organization and Business and Summary of Significant Accounting Policies

Basis of Presentation

These condensed consolidated financial statements of Misonix, Inc. (“Misonix” or the “Company”) include the accounts of Misonix and its 100% owned subsidiaries. All significant intercompany balances and transactions have been eliminated.

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, these financial statements do not include all the information and footnotes required by U.S. GAAP for complete financial statements. As such, they should be read with reference to the Company’s Annual Report on Form 10-K for the fiscal year ended June 30, 2017,2018, which provides a more complete explanation of the Company’s accounting policies, financial position, operating results, business properties and other matters. In the opinion of management, these financial statements reflect all adjustments considered necessary for a fair statement of interim results.

Organization and Business

Misonix designs, manufactures develops and markets minimally invasive therapeutic ultrasonic medical devices. These products are used for precise bone sculpting, removal of soft and hard tumors, and tissue debridement, primarily in the fieldsareas of neurosurgery, orthopedic surgery, plastic surgery, neurosurgery, podiatrywound care and vascularmaxillo-facial surgery. In the United States, the Company sells itsour products are marketed primarily through a network of commissioned agents assistedhybrid sales approach. This includes direct sales representatives, managed by Company personnel.regional sales managers, along with independent distributors. Outside of the United States, the Company sellswe sell BoneScalpel and SonaStar to specialty distributors who thenpurchase products from us to resell to their clinical customer bases. We sell to all major markets in the product to hospitals.Americas, Europe, Middle East, Asia Pacific and Africa. The Company operates as one business segment.

High Intensity Focused Ultrasound Technology

The Company sold its rights to the high intensity focused ultrasound technology to SonaCare Medical, LLC (“SonaCare”) in May 2010. The Company may receive up to approximately $5.8 million in payment for the sale. SonaCare willis obligated to pay the Company 7% of the gross revenues received from its sales of the (i) prostate product in Europe and (ii) kidney and liver products worldwide, until the Company has received payments of $3 million, and thereafter 5% of the gross revenues, up to an aggregate payment of $5.8 million, all subject to a minimum annual royalty of $250,000. No payments were received for the six months ended December 31, 2018 and 2017. Cumulative paymentsroyalties through December 31, 20172018 were $2,292,579.$2,542,579.

Major Customers and Concentration of Credit Risk

Included in revenues are sales to the Company distributor of Bone Scalpel in China of approximately $2,976,000 and $0, for the six months ended December 31, 2018 and 2017, respectively. Accounts receivable from this customer were $300,000 and $0 at December 31, 2018 and June 30, 2018, respectively.

Total royalties from Medtronic Minimally Invasive Therapies (“MMIT”) related to their sales of the Company’s ultrasonic cutting and sculpting products, which use high frequency sound waves to coagulate and divide tissue for both open and laparoscopic surgery, were $0 and $524,000 and $1,885,788 for both the three and six months ended December 31, 20172018 and 2016,2017, respectively. Accounts receivable from MMIT royalties were $925,000$0 at December 31, 2018 and June 30, 2017.2018. The license agreement with MMIT expired in August 2017.

At December 31, 20172018 and June 30, 2017,2018, the Company’s accounts receivable with customers outside the United StatesSates were approximately $627,000$1,715,000 and $860,000,$1,630,000, respectively, none$72,000 of which is over 90 days.days at December 31, 2018.

Use of EstimatesEarnings Per Share

The preparationEarnings per share (“EPS”) is calculated using the two class method, which allocates earnings among common stock and participating securities to calculate EPS when an entity’s capital structure includes either two or more classes of financial statements in conformity with accounting principles generally accepted in the United States requires managementcommon stock or common stock and participating securities. Unvested share-based payment awards that contain non-forfeitable rights to make estimates and judgments that affect the reported amount of assets and liabilities and disclosure of contingent assets and liabilities at the datedividends or dividend equivalents (whether paid or unpaid) are participating securities. As such, unvested restricted stock of the financial statementsCompany are considered participating securities. The dilutive effect of options and their equivalents (including non-vested stock issued under stock based compensation plans), is computed using the reported amounts“treasury” method.

Basic income per common share is based on the weighted average number of revenues and expensescommon shares outstanding during the reporting period. Significant estimatesDiluted income per common share includes the dilutive effect of potential common shares outstanding. The following table sets forth the reconciliation of weighted average shares outstanding and assumptions are used for but not limited to establishing the allowance for doubtful accounts, valuation of inventory, depreciation, asset impairment evaluations and establishing deferred tax assets and related valuation allowances, and stock-based compensation. Actual results could differ from those estimates.diluted weighted average shares outstanding:

Loss Per Share

Diluted EPS for the three and six months ended December 31, 20172018 and 20162017 as presented is the same as basic EPS as the inclusion of the effect of common share equivalents then outstanding would be anti-dilutive. Accordingly, excluded from the calculation of diluted EPS are outstandingthe dilutive effect of options to purchase 375,000530,978 and 521,000375,000 shares of common stock for the three months ended December 31, 20172018 and 2016,2017, respectively, and outstandingthe dilutive effect of options to purchase 1,366,736544,143 and 1,734,6491,366,736 shares of common stock for the six months ended December 31, 2018 and 2017, respectively. Also excluded from the calculation of earnings per share for the three and 2016, respectively.six months ended December 31, 2018 and 2017 are the unvested restricted stock awards which were issued in December 2016.

Recent Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board (the “FASB”) issued guidance onASC Update No. 2014-09, Revenue from Contracts with Customers (Topic 606), which was subsequently updated. The purpose of the updated standard is to provide enhancements to the quality and consistency of revenue from contracts with customers.recognition between companies using U.S. GAAP and International Financial Reporting Standards. The underlyingnew five-step recognition model introduces the core principle is that an entity will recognizeof recognizing revenue to depict the transfer of goods or services to customers atin an amount that reflects the consideration to which the entity expects to be entitled to in exchange for thosethe promised goods or services. The guidance provides a five-step analysis of transactionsservices, which includes additional footnote disclosures to determine when and how revenue is recognized. Other major provisions include capitalization of certain contract costs, consideration of time value of money in the transaction price, and allowing estimates of variable consideration to be recognized before contingencies are resolved, in certain circumstances. The guidance also requires enhanced disclosures regardingdescribe the nature, amount, timing and uncertainty of revenue, certain costs and cash flowsflow arising from an entity’s contractscustomers.

As amended, ASU 2014-09 requires the Company to use either of the following transition methods: (i) a full retrospective approach reflecting the application of the standard in each prior reporting period with customers. This guidance permits the use of eitheroption to elect certain practical expedients; or (ii) a modified retrospective approach with the retrospective or cumulative effect transition method and isof initially adopting ASU 2014-09 recognized at the date of adoption. This standard became effective for the Company beginning in fiscal 2019; early adoption is permitted beginning in 2018. We have not yet selected a transition methodon July 1, 2018 and are currently evaluating the impact ofCompany adopted the guidance onnew pronouncement under the Company’s financial condition, results of operations and related disclosures. The FASB has also issued the following additional guidance clarifying certain issues on revenue from contracts with customers: Revenue from Contracts with Customers - Narrow-Scope Improvements and Practical Expedients and Revenue from Contracts with Customers - Identifying Performance Obligations and Licensing. The Company has engaged a consulting firm to assist with in evaluating this guidance to determine the impact it will have on its financial statements, and expects to complete its evaluation and implementation of necessary procedures and changes, if any, prior to June 30, 2018.modified retrospective approach.

In February 2016, the FASB issued guidance on lease accounting requiring lessees to recognize a right-of-use asset and a lease liability for long-term leases. The liability will be equal to the present value of lease payments. This guidance must be applied using a modified retrospective transition approach to all annual and interim periods presented and is effective for the Company beginning in fiscal 2020. The Company is currently in the early stages of evaluating this guidance to determine the impact it will have on its consolidated financial statements.

In August 2016, the FASB issued guidance on the Statement of Cash Flows Classification of certain cash receipts and cash payments (a consensus of the Emerging Issues Task Force). This guidance addresses the following eight specific cash flow issues: Debt prepayment or debt extinguishment costs; settlement of zero-coupon debt instruments or other debt instruments with coupon interest rates that are insignificant in relation to the effective interest rate of the borrowing; contingent consideration payments made after a business combination; proceeds from the settlement of insurance claims; proceeds from the settlement of corporate-owned life insurance policies (including bank-owned life insurance policies); distributions received from equity method investees; beneficial interests in securitization transactions; and separately identifiable cash flows and application of the predominance principle. This guidance will bebecame effective for the Company beginning in fiscal 2019. The Company is currently in the early stages of evaluatingAs this guidance to determineonly affects the classification within the statement of cash flows, ASU 2016-15 did not have a material impact it will have on itsthe Company’s consolidated financial statements.

In January 2017, the FASB issued ASU No. 2017-01,Business Combinations: Clarifying the Definition of a Business (“ASU 2017-01”). ASU 2017-01 clarifies the definition of a business for determining whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. ASU 2017-01 is effective for annual periods and interim periods within those annual periods beginning after December 15, 2017, and early adoption is permitted. The Company is in the process of evaluating the impact of theCompany’s adoption of ASU 2017-01 did not have a material effect on itsthe Company’s consolidated financial statements.

There are no other recently issued accounting pronouncements that are expected to have a material effect on the Company’s financial position, results of operations or cash flows.

Recently AdoptedCritical Accounting PronouncementsPolicies and Use of Estimates

In March 2016,Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the FASB issued Accounting Standards Update No. 2016-09 “Compensation—Stock Compensation (Topic 718): ImprovementsUnited States requires management to Employee Share-Based Payment Accounting” intendedmake estimates and judgments that affect the reported amount of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Significant estimates and assumptions are used for but not limited to simplify several aspectsestablishing the allowance for doubtful accounts, valuation of accounting for share-based payment transactions. Theinventory, depreciation, asset impairment evaluations and establishing deferred tax assets and related valuation allowances, and stock-based compensation. Actual results could differ from those estimates.

2. Revenue Recognition

On July 1, 2018 the Company adopted these amendments beginning inTopic 606 using the firstmodified retrospective method applied to those contracts which were not completed as of the adoption date. The reported results for the quarter ended December 31, 2018 reflect the application of Topic 606 guidance while the reported results for fiscal 2018. Theyear 2018 were prepared under the guidance requires that all excess tax benefits and tax deficiencies previously recorded as additional paid-in capital be prospectively recorded in income tax expense. The guidance allows for an increase in the threshold for net share settlement up to the maximum statutory rate in employees’ applicable jurisdictions without triggering liability classification.of Topic 605, “Revenue Recognition”. The adoption of this guidance had an immaterialTopic 606 resulted in a cumulative prior period adjustment in the amount of $960,000 related to the Company’s License and Exclusive Manufacturing Agreement described below, but the remainder of the adoption did not have a material impact on income taxesthe timing or amount of revenue recognized.

The impacts of adopting ASC Topic 606 on the Company’s Consolidated Statementconsolidated balance sheets as of OperationsJuly 1, 2018 were as follows:

The Company has made the following accounting policy elections and elected to use certain practical expedients, as permitted by the FASB, in applying Topic 606: 1) the Company accounts for amounts collected from customers for sales and other taxes net of related amounts remitted to tax authorities; 2) the Company expenses costs to obtain a contract as they are incurred if the expected period of benefit, and therefore the amortization period, is one year or less; 3) the Company accounts for shipping and handling activities that occur after control transfers to the customer as a fulfillment cost rather than an additional promised service and these fulfillment costs fall within selling, general and administrative expenses; 4) the Company does not assess whether promised goods or services are performance obligations if they are immaterial in the context of the contract with the customer; 5) the Company will utilize the right-to-invoice practical expedient with regard to the recognition of revenue upon the purchase of consumable goods in connection with a product placement/consignment arrangement.

The Company determines revenue recognition through the following steps:

Contracts and Performance Obligations

The Company accounts for a contract with a customer when there is an approval and commitment from both parties, the rights of the parties are identified, payment terms are identified, the contract has commercial substance and collectability of the consideration is probable. The Company’s performance obligations consist mainly of transferring control of products and related services identified in the contracts, purchase orders or invoices. For each contract, the Company considers the obligation to transfer products or bundled products and services to the customer, of which each is distinct in the context of the contract, to be performance obligations. The Company historically has not made provisions for returns and allowances as they have not been material to the operations of the Company.

Transaction Price and Allocation to Performance Obligations

Transaction prices of products are typically based upon contracted rates as specified on the purchase order for the threepurchase of consumables which represents the standalone selling price as determined through the sale of products and six months ended December 31, 2017.or bundled products or services separately in similar circumstances to similar customers. The Company electeddetermines the effects of variable consideration, inclusive of any constraints, in determining the transaction price with regard to applytheir contracts with customers.

Recognition of Revenue

The Company satisfies performance obligations over time, or at a point in time, upon which control transfers to the presentation requirementcustomer.

Revenue derived from the shipping and billing of product is recorded upon shipment, when transfer of control occurs for products shipped F.O.B. shipping point. Products shipped F.O.B. destination point are recorded as revenue when received at the point of destination when the transfer of control is completed. Shipments under agreements with distributors are not subject to return, and payment for these shipments is not contingent on sales by the distributor. Accordingly, the Company recognizes revenue on shipments to distributors in the same manner as with other customers under the ship and bill process.

Revenue derived from the rental of equipment is recorded on a monthly basis over the term of the lease. Shipments of consumable products to these rental customers is recorded as orders are received and shipments are made F.O.B. destination or F.O.B. shipping point.

Revenue derived from consignment agreements is earned as consumables product orders are fulfilled. Therefore, revenue is recognized as shipments are made F.O B shipping point or F.O.B destination.

Revenue derived from service and maintenance contracts is recognized evenly over the life of the service agreement as the services are performed.

Contract Specific Performance Obligations and Significant Judgements

Product Placement/Consignment Agreements

The Company’s product placement/consignment agreements include the placement of a generator at the customer’s place of business and pricing related to the purchase of consumables for use in conjunction with the generator. These agreements have no stated minimum consumable purchase quantities nor a stated term. The Company considers the transaction price in these arrangements to be fully constrained variable consideration because it is dependent on future sales of consumables to the customer. The Company has determined that the pattern of purchase of consumables by a customer is consistent with the benefit received by the customer for the use of the generator and therefore the Company has a right to consideration based upon the pattern of consumable purchases placed through purchase orders by the customer. The Company’s invoices to these customers have short-term payment terms and are aligned with the transfer of goods and services to the customer and the Company recognizes revenue based upon their right to invoice customers.

License and Manufacturing Agreement

On October 19, 2017, the Company entered into a License and Exclusive Manufacturing Agreement (the “Agreement”) with Hunan Xing Hang Rui Kang Bio-technologies Co., Ltd, a Chinese corporation (the “Licensee”) under which Misonix has licensed certain manufacturing and distribution rights to its SonaStar product line in China, Hong Kong and Macau in exchange for payments consisting of initial payments totaling $5,000,000 for the transfer of functional intellectual property and initial stocking orders of product, and minimum royalty payments of $2,000,000 per calendar year for three years beginning in 2019, based upon the manufacture of products by the Licensee. $5,000,000 of initial revenue was collected and recorded for the quarter ended March 31, 2018 under ASC 605. Upon the adoption of Topic 606, the Company evaluated this contract under the provisions of the new revenue standard. The Company determined that the satisfied performance obligations and allocation of the transaction price related to the $5,000,000 received prior to adoption was consistent with the provisions of ASC 606 and also recorded a transitional adjustment to accumulated deficit in the amount of $960,000 as follows:

Although the contract includes minimum royalties, the Company concluded that a significant portion of those guaranteed minimums are actually variable consideration subject to the constraint because the Company has provided an implicit price concession. Specifically, the fact that production of the product in China is not assured and the Licensee must develop a manufacturing process, coupled with the fact that new technology related to this product is expected to be available for sale domestically, may result in the Licensee not earning sufficient revenue in order to pay the minimum royalties. Therefore, the Company has determined variable consideration through utilization of the most likely method based upon forecasts and projections of shipment of products.

The Company will monitor facts and circumstances over time and adjust management’s most likely estimate of variable consideration on a quarterly basis.

Disaggregation of Revenue

The Company generates revenue from the sale and leasing of medical equipment and from the sale of consumable products used with such equipment in surgical procedures as well as through product licensing arrangements. In the United States, the Company’s products are marketed primarily through a hybrid sales approach which includes direct sales representatives, managed by regional sales managers, along with independent distributors. Outside the United States, the Company sells BoneScalpel and SonaStar to specialty distributors who purchase products to resell to their clinical customer bases. The Company sells to all major markets in the Americas, Europe, Middle East, Asia Pacific, and Africa. Revenue is disaggregated from contracts between products under ship and bill arrangements and licensing agreements, and by geography, which the Company believes best depicts how the nature, amount, timing and uncertainty of revenues and cash flows related to excess tax benefits prospectively, which hadare affected by economic factors. The Company also provides an immaterial impact on both net cash from operating activitiesamount of service revenue which is recognized over time, but not stated separately because the amounts are immaterial.

The following table disaggregates the Company’s product revenue by classification and net cash used in financing activitiesgeographic location:

There was no license revenue for the threeperiods presented.

Contract Assets

The timing of revenue recognition, customer invoicing, and six months ended December 31, 2017. The presentation requirements for cash flows related to employee taxes paid for withheld shares had no impact on any of the periods presentedcollections produces accounts receivable and contract assets on the Company’s Consolidated Statementsconsolidated balance sheet. Contract liabilities are not material to the operations of Cash Flows since such cash flows have historically been presentedthe Company as of December 31, 2018. The Company invoices in accordance with contract payment terms. Customer invoices represent an unconditional right of consideration. When revenue is recognized in advance of customer invoicing a contract asset is recorded. Unpaid customer invoices are reflected as accounts receivable.

The contract asset represents an asset in conjunction with the Company’s License and Manufacturing Agreement related to the most likely variable consideration associated with the royalty provisions in the contract. The asset is recorded as a financing activity. Finally,long-term asset as the Company believes that payment will be made on this asset in a duration to exceed one year. Contract assets as of December 31, 2018 and June 30, 2018 were $960,000 and $0, respectively.

Selling Costs

Incremental direct costs of obtaining a contract primarily include sales commissions paid to sales personnel and outside sales representatives in connection with sales of products under ship and bill scenarios or through product placement scenarios. The expected period of benefit of these costs is one year or less and therefore the Company has elected the practical expedient to account for forfeitures asexpense such costs in the period in which they occur, rather than estimate expected forfeitures. As a result,are incurred. Typically, these costs represent shipping and handling costs and the Company recorded the cumulative impact of $908,875accounts for these costs as fulfillment costs and are expensed as incurred. Costs in fulfilling a contract are only capitalized as an increaseasset if they relate directly to Deferred Income Taxes with a corresponding decreasean existing contract or specific anticipated contract, they generate or enhance resources of the entity that will be used to Accumulated Deficit.satisfy performance obligations in the future, and they are expected to be recovered. The Company has not identified any such costs.

2.3. Fair Value of Financial Instruments

We followThe Company follows a three-level fair value hierarchy that prioritizes the inputs to measure fair value. This hierarchy requires entities to maximize the use of “observable inputs” and minimize the use of “unobservable inputs.” The three levels of inputs used to measure fair value are as follows:

Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets as of the measurement date.

Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.

Level 3: Significant unobservable inputs that reflect assumptions that market participants would use in pricing an asset or liability.

At December 31, 20172018 and June 30, 2017,2018, all of ourthe Company’s cash and cash equivalents, trade accounts receivable and trade accounts payable were short term in nature, and their carrying amounts approximate fair value.

3.4. Inventories

Inventories are summarized as follows:

4.5. Property, Plant and Equipment

Depreciation and amortization of property, plant and equipment was $615,000$698,000 and $429,000$615,000 for the six months ended December 31, 20172018 and 2016,2017, respectively. Inventory items included in property, plant and equipment are depreciated using the straight line method over estimated useful lives of 3 to 5 years. Depreciation of generators which are consigned to customers wasis expensed over a 5 year5-year period, during the six months ended December 31, 2017 and was expensed over a 3 year period for the six months ended December 31, 2016, and depreciation wasis charged to selling expenses.

5.6. Goodwill

The excess of the cost over the fair value of net assets of acquired businesses is recorded as goodwill. Goodwill is not amortized. We review goodwillsubject to amortization, but is reviewed for impairment at the reporting unit level annually, and whenever events or changes indicate thatmore frequently if impairment indicators arise. The Company’s assessment of the recoverability of goodwill is based upon a comparison of the carrying value of an asset may not be recoverable. These events or circumstances could include a significant change ingoodwill with its estimated fair value and the business climate, legal factors, operating performance indicators, competition, or sale or dispositionvalue of significant assets or products. the Company at the measurement date.

Application of these impairment tests requires significant judgments, including estimation of cash flows, which is dependent on internal forecasts, estimation of the long term rate of growth for the Company’sour business, the useful lives over which cash flows will occur and determination of the Company’sour weighted average cost of capital. The Company primarily utilizes the Company’s market capitalization and a discontinued cash flow model in determiningexceeds the fair value which consists of Level 3 inputs. Changes in the projected cash flows and discount rate estimates and assumptions underlying the valuation of goodwill could materially affect the determination of fair value at acquisition or during subsequent periods when tested for impairment.goodwill. The Company completed its annualconcluded that there was no impairment to goodwill impairment tests for fiscal 2017 and 2016 as ofat June 30, of each year.2018 and June 30, 2017. There were no triggering events identified during the quarter ended December 31, 2017.2018.

6.7. Patents

The costs of acquiring or processing patents are capitalized at cost. These amounts are being amortized using the straight-line method over the estimated useful lives of the underlying assets, which is approximately 17 years. Patents, net of accumulated amortization, totaled $715,032$763,044 and $719,136$757,447 at December 31, 20172018 and June 30, 2017,2018, respectively. Amortization expense for the six months ended December 31, 2018 and 2017 was $70,000 and 2016 was $61,000, and $53,000, respectively. The following is a schedule of estimated future patent amortization expenses by fiscal year as of December 31, 2017:2018:

7.8. Accrued Expenses and Other Current Liabilities

The following summarizes accrued expenses and other current liabilities:

8.9. Stock-Based Compensation Plans

Stock Option Awards

For the three and six months ended December 31, 20172018 and 2016,2017, the compensation cost relating to stock option awards that has been charged against income for the Company’s stock option plans was $500,087 and $844,601, and $1,504,586 and $1,016,026, and $83,865 respectively, which included a charge to modify certain stock options of $81,765 and a reversal of stock compensation from prior periods due to forfeitures of unvested options of $616,239, for the six months ended December 31, 2016.respectively. As of December 31, 2017,2018, there was approximately $5,787,705$2,928,738 of total unrecognized compensation cost related to non-vested share-based compensation arrangements to be recognized over a weighted-average period of 3.02.7 years.

Stock options typically expire 10 years from the date of grant and vest over service periods, which typically are 4 years. All options are granted at fair market value, as defined in the applicable plans.

The fair value of each option award was estimated on the date of grant using the Black-Scholes option valuation model that uses the assumptions noted in the following table. The expected volatility represents the historical price changes of the Company’s stock over a period equal to that of the expected term of the option. The Company uses the simplified method for determining the option term. The risk-free rate was based on the U.S. Treasury yield curve in effect at the time of grant. The expected dividend yield is based upon historical and projected dividends. The Company has historically not paid dividends, and is not expected to do so in the near term.

The weighted average fair value per share at date of grant for options granted during the six months ended December 31, 20172018 was $5.50.$8.51. There were options to purchase 305,500182,000 and 327,500305,500 shares granted during the six months ended December 31, 20172018 and 2016,2017, respectively. The fair value was estimated based on the weighted average assumptions of:

A summary of option activity under the Company’s equity plans as of December 31, 2017,2018, and changes during the six months ended December 31, 20172018 is presented below:

The total fair value of sharesstock options vested during the six months ended December 31, 20172018 was $924,483.$999,195. The number and weighted-average grant-date fair value of non-vested stock options at the beginning of fiscal 2018 was 673,875648,877 and $4.77,$5.08, respectively. The number and weighted-average grant-date fair value of stock options which vested during the six months ended December 31, 20172018 was 193,123194,374 and $4.79,$5.14, respectively.

Restricted Stock Awards

On December 15, 2016, the Company issued 400,000 shares of restricted stock to its Chief Executive Officer. These awards vest over a period of up to five years, subject to meeting certain service, performance and market conditions. These awards were valued at approximately $3.6 million and compensationmillion. Compensation expense recorded in the six months ended December 31, 2018 and 2017 related to these awards was $453,868.$871,329 and $453,868 respectively. As of December 31, 2017, 26,8002018, there was approximately $1,377,319 of total unrecognized compensation cost related to non-vested restricted stock awards to be recognized over a weighted-average period of 2.81 years. The awards contain a combination of vesting terms which include time vesting, performance vesting relating to revenue achievement, and market vesting related to obtaining certain levels of Company stock prices. At December 31, 2018, the Company has estimated that it is probable that the performance conditions will be met. The awards were valued using a Monte Carlo valuation model using a stock price at the date of grant of $9.60, a term of 3 to 5 years, a risk free interest rate of 1.6% to 2.1% and a volatility factor of 66.5%. As of December 31, 2018, 186,600 shares from this set of awards have vested.

During the six months ended December 31, 2018, the performance conditions of one of these restricted stock awards were met, resulting in the full amortization of this award during the period, totaling $475,286 of additional amortization during the first quarter of the current fiscal year. The number of restricted stock awards which vested was 133,333.

9.10. Commitments and Contingencies

Leases

The Company has entered into several non-cancellable operating leases for the rental of certain manufacturing and office space, equipment and automobiles expiring in various years through 2021. The principal building lease provides for a monthly rental of approximately $26,000. The Company also leases certain office equipment and automobiles under operating leases expiring through March 2019.$28,000.

Class Action Securities Litigation

On September 19, 2016, Richard Scalfani, an individual shareholder of Misonix, filed a lawsuit against the Company and its former CEO and CFO in the U.S. District Court for the Eastern District of New York, alleging violations of the federal securities laws. The complaint alleges that the Company’s stock price was artificially inflated between November 5, 2015 and September 14, 2016 as a result of alleged false and misleading statements in the Company’s securities filings concerning the Company’s business, operations, and prospects and the Company’s internal control over financial reporting. Scalfani filed the action seeking to represent a putative class of all persons (other than defendants, officers and directors of the Company, and their affiliates) who purchased publicly traded Misonix securities between November 5, 2015 and September 14, 2016. Scalfani was seeking an unspecified amount of damages for himself and for the putative class under the federal securities laws. On March 24, 2017, the Court appointed Scalfani and another individual Misonix shareholder, Tracey Angiuoli, as lead plaintiffs for purposes of pursuing the action on behalf of the putative class. The lead plaintiffs, on behalf of the putative class, and the Company reached a settlement in principle under which the Company would pay $500,000 to resolve the matter. The district court approved the settlement and dismissed the lawsuit with prejudice in an order dated December 16, 2017. The Company has paid its $250,000, representing its insurance retention. The balance was paid by the Company’s insurance carrier.

Former Chinese Distributor - FCPA

With the assistance of outside counsel, the Company conducted a voluntary investigation into the business practices of the independent Chinese entity that previously distributed its products in China and the Company’s knowledge of those business practices, which may have implications under the FCPA, as well as into various internal controls issues identified during the investigation.

investigation (the “Investigation”). On September 27, 2016 and September 28, 2016, the Company voluntarily contacted the SEC and the DOJ, respectively, to advise both agencies of these potential issues. The Company has provided and will continue to provide documents and other information to the SEC and the DOJ, and is cooperating fully with these agencies in their ongoing investigations of these matters.

Although the Company’s investigationInvestigation is complete, additional issues or facts could arise which may expand the scope or severity of the potential violations. The Company has no current information derived from the investigationInvestigation or otherwise to suggest that its previously reported financial statements and results are incorrect.

At this stage, the Company is unable to predict what, if any, action the DOJ or the SEC may take or what, if any, penalties or remedial measures these agencies may seek. Nor can the Company predict the impact on the Company as a result of these matters, which may include the imposition of fines, civil and criminal penalties, which are not currently estimable, as well as equitable remedies, including disgorgement of any profits earned from improper conduct and injunctive relief, limitations on the Company’s conduct, and the imposition of a compliance monitor. The DOJ and the SEC periodically have based the amount of a penalty or disgorgement in connection with an FCPA action, at least in part, on the amount of profits that a company obtained from the business in which the violations of the FCPA occurred. During its distributorship relationship with the prior Chinese distributor from 2010 through 2016, the Company generated revenues of approximately $8 million.

Further, the Company may suffer other civil penalties or adverse impacts, including lawsuits by private litigants in addition to the lawsuits that already have been filed, or investigations and fines imposed by local authorities. The investigative costs to date are approximately $2.8$3.4 million, of which approximately $0.1$0.3 million and $0.3$0.4 million was charged to general and administrative expenses during the three and six months ended December 31, 2017,2018, respectively, compared with $0.6$0.1 million and $1.4$0.3 million for the three and six months ended December 31, 2016.2017.

Former Chinese Distributor – Litigation

On April 5, 2017, the Company’s former distributor in China, Cicel (Beijing) Science & Technology Co., Ltd., filed a lawsuit against the Company and certain officers and directors of the Company in the United States District Court for the Eastern District of New York, alleging that the Company improperly terminated its contract with the former distributor. The complaint sought various remedies, including compensatory and punitive damages, specific performance and preliminary and post judgment injunctive relief, and asserted various causes of action, including breach of contract, unfair competition, tortious interference with contract, fraudulent inducement, and conversion. On October 7, 2017, the court granted the Company’s motion to dismiss all of the tort claims asserted against it, and also granted the individual defendants’ motion to dismiss all claims asserted against them. The only claim currently remaining in the case is for breach of contract against the Company.Company; the plaintiff has moved to amend its complaint to add tort claims, which the Company has opposed. The Company believes it has various legal and factual defenses to the allegations in the complaint, and intends to vigorously defend the action. The case is at its earliest stages; discovery is just beginning and there is no trial date.

Stockholder Derivative Litigation

On June 6, 2017, Irving Feldbaum, an individual shareholder of Misonix, filed a lawsuit in the U.S. District Court for the Eastern District of New York. The complaint alleges claims against the Company’s board of directors, its former CEO and CFO, certain of its former directors, and the Company as a nominal defendant for alleged violations of Section 14(a) of the Securities Exchange Act of 1934 and state law claims for breach of fiduciary duty, waste of corporate assets, and unjust enrichment. The complaint alleges that the Company incurred damages as a result of alleged false and misleading statements in the Company’s securities filings concerning the Company’s business, operations, and prospects and the Company’s internal control over financial reporting. The complaint also alleges that the Company’s February 4, 2016 Proxy Statement contained false and misleading statements regarding executive compensation. The complaint seeks the recovery of damages on behalf of the Company and the implementation of changes to corporate governance procedures. On June 16, 2017, Michael Rubin, another individual shareholder of Misonix, filed a case alleging similar claims in the same district court. On July 21, 2017, the district court consolidated the two actions for all purposes. The caseOn July 16, 2018, the Company and counsel for Mr. Feldbaum and Mr. Rubin informed the District Court that the parties had reached a settlement in principle. There are aspects of the settlement that remain to be negotiated and documented, and the settlement is at its earliest stages; there has been no discovery and there is no trial date. The Company is not able eithersubject to estimateapproval by the amount of potential loss it may recognize, if any, from these claims orDistrict Court after notice to identify any changes in corporate governance procedures it may undertake, if any, as a result of these claims.the Company’s shareholders.

10.11. Related Party Transactions

OrthoXact Proprietary Limited (“OrthoXact”) (formerly Applied BioSurgical) is an independent distributor for the Company in South Africa. The chief executive officer of OrthoXact is also the brother of Stavros G. Vizirgianakis, the CEO of Misonix, Inc.

Set forth below is a table showing the Company’s net revenues for the six months ended December 31 and accounts receivable at December 31 for the indicated time periodsperiod below with OrthoXact:

11.12. Income Taxes

For the three and six months ended December 31, 20172018 and 2016,2017, the Company recorded income tax expense (benefit), as follows:

For the six months ended December 31, 20172018 and 2016,2017, the effective rate of 185.6%0% and (4.7)%185.6%, respectively, varied from the U.S. federal statutory rate primarily due to the recording of a full valuation allowance on the remaining deferred tax assets, permanent book tax differences relating principally to stock compensation expense and tax credits, and the impact of the Tax Cuts and Jobs Act of 2017.

Tax Cuts and Jobs Act of 2017

The Tax Cuts and Jobs Act of 2017, (the “Tax Legislation”), enacted on December 22, 2017, contains significant changes to U.S. tax law, including lowering the U.S. corporate income tax rate to 21%, implementing a territorial tax system, and imposing a one-time tax on deemed repatriated earnings of foreign subsidiaries.

The Tax Legislation reduces the U.S. statutory tax rate from 35% to 21%, effective January 1, 2018. U.S. tax law requires that taxpayers with a fiscal year that begins before and ends after the effective date of a rate change calculate a blended tax rate based on the pro rata number of days in the fiscal year before and after the effective date. As a result, for the fiscal year ending June 30, 2018, the Company’s statutory income tax rate will be 29.03%. For the fiscal year ending June 30, 2019, the Company’s statutory income tax rate will be 22.62%.

On December 22, 2017, the SEC staff issued Staff Accounting Bulletin No. 118 (“SAB 118”), which provides guidance on accounting for the tax effects of the Tax Legislation. SAB 118 provides a measurement period that should not extend beyond one year from the Tax Legislation enactment date for companies to complete the accounting under ASC 740, Income Taxes. In accordance with SAB 118, a company must reflect the income tax effects of those aspects of the Tax Legislation for which the accounting under ASC 740 is complete. To the extent that a company’s accounting for certain income tax effects of the Tax Legislation is incomplete but it is able to determine a reasonable estimate, it must record a provisional estimate in the financial statements. During the three months ended December 31, 2017, using the information available at the time, the Company recorded a provisional $1,764,039 discrete tax expense representing the expense of remeasuring its U.S. deferred tax assets at the lower 21% statutory tax rate. The Company may make additional adjustments in fiscal 2018 as further information is identified to properly record this adjustment.

Valuation Allowance on Deferred Tax Assets

Deferred tax assets refer to assets that are attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets in essence represent future savings of taxes that would otherwise be paid in cash. The realization of the deferred tax assets is dependent upon the generation of sufficient future taxable income, including capital gains. If it is determined that the deferred tax assets cannot be realized, a valuation allowance must be established, with a corresponding charge to net income.

In accordance with ASC Topic 740, the Company establishes valuation allowances for deferred tax assets that, in its judgment are not more likely-than-not realizable. The guidance requires entities to evaluate all available positive and negative evidence, including cumulative results in recent periods, weighted based on its objectivity, in determining whether its deferred tax assets are more likely than not realizable.

The Company regularly assesses its ability to realize its deferred tax assets. While the Company had positive cumulative pretax income as of June 30, 2017, based on actual results to datefor fiscal 2018 and the Company’s current forecast for fiscal 2019 the Company is in a three-year cumulative loss position at December 31, 2018, and it expects to be in a cumulative pretax loss position as of June 30, 2018.2019. Management evaluated available positive evidence, including the continued growth of the Company’s revenues and gross profit margins, its recent SonaStar technology salelicense to its Chinese partner and the reduction in investigative and professional fees recognized in fiscal 2017, along with available negative evidence, including the Company’s continuing investment in building its next generation Nexus platform and its continuing investment in building a direct sales force, while at the same time paying commissions to its domestic sales distributors. After weighing both the positive and negative evidence, management concluded that the Company’s deferred tax assets are not more likely-than-not realizable. Accordingly, the Company recorded a full valuation allowance of $3,988,532 against its remaining deferred tax assets at December 31, 2017.assets. The Company will continue to assess its ability to utilize its net operating loss carryforwards, and will reverse this valuation allowance when sufficient evidence is achieved to allow the realizability of such deferred tax assets.

As of December 31, 20172018 and June 30, 2017,2018, the Company hashad no material unrecognized tax benefits or accrued interest and penalties.

12. Licensing Agreements for Medical Technology

On October 19, 2017, the Company entered into a License and Exclusive Manufacturing Agreement (the “Agreement”) with Hunan Xing Hang Rui Kang Bio-technologies Co., Ltd., a Chinese corporation (the “Licensee”) under which Misonix has licensed certain manufacturing and distribution rights to its SonaStar product line in China, Hong Kong and Macau (the “Territory”) in exchange for payments totaling at least $11,000,000.

Pursuant to the Agreement, Licensee is obligated to pay the Company: (i) initial amounts consisting of upfront fees and stocking orders totaling $5,000,000, payable in five (5) equal monthly installments of $1,000,000 each; (ii) royalty payments from the sale of SonaStar products in the Territory, including minimum royalty payments of $2,000,000 per calendar year in each of 2019, 2020, and 2021; and (iii) reimbursement of technology transfer costs in an amount up to $1,000,000. The Agreement also provides that Misonix will supply SonaStar products to Licensee at agreed prices during the transition period prior to Licensee’s commencement of manufacturing.

In October 1996, the Company entered into a license agreement with MMIT which expired August 2017, covering the further development and commercial exploitation of the Company’s medical technology relating to laparoscopic products, which uses high frequency sound waves to coagulate and divide tissue for both open and laparoscopic surgery. The MMIT license provided for exclusive worldwide marketing and sales rights for this technology. The Company received a 5% royalty on sales of these products by MMIT. Royalties from this license agreement were $524,000 and $1,886,000 for the six months ended December 31, 2017 and 2016, respectively. This royalty agreement expired in August 2017.

13. Segment Reporting

Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated on a regular basis by the chief operating decision-maker (“CODM”) in deciding how to allocate resources to an individual segment and in assessing performance of the segment. The Company has concluded that its Chief Executive Officer is the CODM as he is the ultimate decision maker for key operating decisions, determining the allocation of resources and assessing the financial performance of the Company. These decisions, allocations and assessments are performed by the CODM using consolidated financial information. Consolidated financial information is utilized by the CODM as the Company’s current product offering primarily consists of minimally invasive therapeutic ultrasonic medical devices. The Company’s products are relatively consistent and manufacturing is centralized and consistent across product offerings. Based on these factors, key operating decisions and resource allocations are made by the CODM using consolidated financial data and as such the Company has concluded that it operates as one segment.

Worldwide revenue for the Company’s products and license revenue is categorized as follows:

Substantially all of the Company’s long-lived assets are located in the United States.

14. Severance

On August 26, 2016, the Company and the Company’s former Chief Executive Officer, Michael McManus (“McManus”) entered into a retirement agreement and general release (the “Retirement Agreement”). Pursuant to the Retirement Agreement, on September 2, 2016 Mr. McManus resigned as a Director and the Chairman of the Board of Directors of the Company and retired as President and Chief Executive Officer of the Company. Pursuant to the Retirement Agreement, the Company agreed to (i) pay Mr. McManus’ salary through June 30, 2017 at the then current level; (ii) continue to pay premiums for Mr. McManus’ and his dependents’ coverage under the Company’s medical, dental, vision, hospitalization, long term care and life insurance coverage through June 30, 2017 at the then current levels upon timely election by Mr. McManus under the law informally known as COBRA; and (iii) extend the exercisability of previously granted and then currently vested options to purchase shares of Common Stock through June 30, 2017. In addition, Mr. McManus had continued use of the vehicle provided him pursuant to his prior employment agreement through December 31, 2016. In connection with this Retirement Agreement, the Company recorded a charge of $330,000 during the quarter ended September 30, 2016 to accrue for the cash portion of these benefits, which was paid during the fiscal year ended June 30, 2017. In addition, during the quarter ended June 30, 2016, the Company recorded a non-cash compensation expense of $61,000 in connection with the modification of the terms of his vested stock options, and recorded a reduction in non-cash compensation expense of $596,000 relating to the forfeiture of his unvested stock options.

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

This Management’s Discussion and Analysis of Financial Condition and Results of Operations of Misonix and its subsidiaries, which we refer to as the “Company”, “Misonix”, “we”, “our” and “us”, should be read in conjunction with the accompanying unaudited financial statements included in Part I – Item 1 “Financial Statements” of this Report and Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K, filed with the Securities and Exchange Commission (the “SEC”) on August 24, 2017,September 13, 2018, for the fiscal year ended June 30, 20172018 (“20172018 Form 10-K”). Item 7 of the 20172018 Form 10-K describes the application of our critical accounting policies, for which there have been no significant changes during the three and six months ended December 31, 2017.2018.

Forward Looking Statements

With the exception of historical information contained in this Form 10-Q, content herein may contain “forward looking statements” that are made pursuant to the Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995. These statements are based on management’s current expectations and are subject to uncertainty and changes in circumstances. We cannot guarantee that any forward looking statements will be accurate, although we believe that we have been reasonable in our expectations and assumptions. Investors should realize that if underlying assumptions prove inaccurate or unknown risks or uncertainties materialize, actual results could vary materially from our expectations and projections. These factors include general economic conditions, delays and risks associated with the performance of contracts, risks associated with international sales and currency fluctuations, uncertainties as a result of research and development, acceptable results from clinical studies, including publication of results and patient/procedure data with varying levels of statistical relevance, risks involved in introducing and marketing new products, regulatory compliance, potential acquisitions, consumer and industry acceptance, litigation and/or contemplated 510(k) filings, the ability to achieve and maintain profitability in our business lines, the pending FCPA investigation and other factors discussed in the 20172018 Form 10-K, subsequent Quarterly Reports on Form 10-Q and Current Reports on Form 8-K. We disclaim any obligation to update any forward-looking statements.

Overview

Misonix designs, manufactures develops and markets minimally invasive therapeutic ultrasonic medical devices. These products are used for precise bone sculpting, removal of soft and hard tumors, and tissue debridement, primarily in the areas of neurosurgery, orthopedic surgery, plastic surgery, wound care and wound and burn care.maxillo-facial surgery. In the United States, the Company sells its products through its direct sales force, in addition to a network of commissioned agents assisted by Company personnel. Outside of the United States, the Company generally sells to distributors who then resell the productproducts to hospitals. The Company operates as one business segment.

In the United States, the Company is taking a more aggressive approach to taking market share, expanding the market and increasing its share of recurring disposable revenue by using a consignment model, whereby the Company will consign the equipment (which is defined as a generator, hand units and accessories) (the “Equipment”) and sell to customers higher margin disposable, single use items (the “Consumables”) on a recurring basis. Title remains with the Company with respect to consigned Equipment, which is depreciated and charged to selling expenses over a five year period beginning in fiscal 2017, and a three year period in fiscal 2016. Outside of the United States, the Company has principally not yet adopted a consignment model.period. The Company’s overall goal is to increase the utilization rate of Equipment which will increase the total number of procedures and maximize the sale of Consumables to our customers, with the goal of becoming the standard of care in the various segmentsmedical procedures we focus on.

Results of Operations

The following discussion and analysis provides information which the Company’s management believes is relevant to an assessment and understanding of the Company’s results of operations and financial condition. This discussion should be read in conjunction with the consolidated financial statements and notes thereto appearing elsewhere herein. Unless otherwise specified, this discussion relates solely to the Company’s continuing operations.

All of the Company’s revenues have been derived from the sale of medical device products, which include manufacture and distribution of ultrasonic medical device products.

Three months ended December 31, 20172018 and 20162017

Our revenues by category for the three months ended December 31, 20172018 and 20162017 are as follows:

Revenues

RevenuesTotal revenue increased 38.0%22.3% or $2,293,465$1.9 million to $8,323,845$10.2 million in the second quarter of fiscal 2018,2019, from $6,030,380$8.3 million in fiscal 2017. Consumables revenue in the United States increased 20.3%, or $778,936 for the second quarter principallyof fiscal 2018. The largest portion of the revenue increase was due to the strengthcontinued growth of consumables in the Company’sdomestic and international markets as expected. Domestic sales of BoneScalpel product line, which grew 36% duringand SonicOne were strong, and the quarter. exceptional growth is in the wound franchise continued.

Domestic equipment revenues grew by 185.0%were below expectations due to timing issues with customers, while international equipment revenues were above expectations with continued momentum in China and other key markets.

The revenue increase is principally attributable to a 22.9% or $1.4 million increase in consumables revenue, in addition to a 20.6% or $0.4 million increase in equipment revenue.

There was no license revenue during the second quarter resulting from strong SonaStar sales.of fiscal 2019 or fiscal 2018.

International revenue grew 52.8% during the second quarter, largely due to a 60% growth in SonaStar sales and a 26% growth in BoneScalpel sales.

Gross profit

Gross profit from product revenue in the second quarter of fiscal 20182019 was 70.4%70.0% of revenue, which increased from 69.8%compared with the gross profit margin of 70.4% in the second quarter of fiscal 2017. The increase resulted from a stronger mix of higher margin product.2018.

Selling expenses

Selling expenses increased by $648,381,$0.9 million, or 19.8%22.5% to $3,919,515$4.8 million in the second quarter of fiscal 20182019 from $3,271,134$3.9 million in the prior year period. The increase is principally related to higher compensation costs and travel related expenses resulting from the continued buildout of the Company’s direct sales force, along with higher commissions relating to the 38% increase in revenue.force.

General and administrative expenses

General and administrative expenses increased by $293,441, or 14.1% to $2,380,860were $2.3 million, roughly flat with $2.4 million in the second quarter of fiscal 2018 from $2,087,419 in the prior year period. This increase is principally related to an increase of2018. Higher salaries and benefits were largely offset by lower non-cash compensation expense for the second quarter of fiscal 2018 of $439,000 related to restricted stock and stock option grants to the Company’s board of directors and its current CEO, a decrease in professional fees of $266,000 and a decrease in accrued vacation costs of $118,000. During the second quarter of the prior year, the Company was incurring higher costs for its internal investigation.costs.

Research and development expenses

Research and development expenses increaseddecreased by $516,840,$0.1 million or 117.4%12% to $957,204$0.8 million in the second quarter of fiscal 20182019 from $440,364$1.0 million in the prior year period. The Company is investing in the design and development of its next generation platform product, Nexus, which is expected to be available in fiscal 2019. During the second quarter of fiscal 2019 and fiscal 2018, approximately $600,000$0.3 million and $0.6 million, respectively, was charged to research and development expenses related to this product.

Other income (expense)

Other income decreased by $875,219 to $67,208was $18,339 in the second quarter of fiscal 2018 from $942,4272019 compared with $67,208 in the prior year period. TheThis decrease is related to lower royalty income from MMIT. This royalty agreement expired in August 2017. There were no license fees recorded during the second quarter of fiscal 2018.income.

Income taxes

For the three months ended December 31, 20172018 and 2016,2017, the Company recorded an income tax expense (benefit) of $5,524,422$0 and ($30,000),$5.5 million, respectively. For the three months ended December 31, 20172018 and 2016,2017, the effective rate of 414.6%0% and (4.7%)414.6%, respectively, varied from the U.S. federal statutory rate due to changes in the Company’s projected pretax book income.

The income tax expense for the second quarter of fiscal 2018 included a one-time charge of $1,764,039 to revalue the Company’s deferred tax assetassets as of December 31, 2017 to give effect to the reduction in corporate tax rates to 21% effective January 1, 2018, as a result of the Tax Cuts and Jobs Act of 2017, (the “Tax Legislation”)enacted on December 22, 2017. Income tax expense also included a $3,988,532 charge to record a full valuation allowance against the Company’s remaining deferred tax assets. In accordance with the guidance of ASC Topic 740, management concluded that in its judgment, the Company’s deferred tax assets at December 31, 2017 are not more likely-than-not realizable.

Income tax expense for the quarter ended December 31, 2018 includes a $228,000 valuation allowance against the Company’s deferred tax assets recorded in the quarter. In accordance with the guidance of ASC Topic 740, management concluded that in its judgment, the Company’s deferred tax assets at December 31, 2018 are not more likely-than-not realizable. The components of the tax provision are as follows:

Six months ended December 31, 2018 and 2017

Our revenues by category for the six months ended December 31, 2018 and 2017 are as follows:

Revenues

Total revenue increased 25.2% or $3.9 million to $19.5 million during the first half fiscal 2019, from $15.6 million in the prior year period. The largest portion of the revenue increase was due to the continued growth of consumables in the domestic and international markets as expected. Domestic sales of BoneScalpel and SonicOne were strong, and the exceptional growth is in the wound franchise continued.

Domestic equipment revenues were below expectations due to timing issues with customers, while international equipment revenues were above expectations with continued momentum in China and other key markets.

The revenue increase is principally attributable to a 20.9% or $2.4 million increase in consumables revenue, in addition to a 37.2% or $1.5 million increase in equipment revenue.

There was no license revenue during the first half of fiscal 2019 or fiscal 2018.

Gross profit

Gross profit from product revenue in the first half of fiscal 2019 was 70.3% of revenue, compared with the gross profit margin of 70.2% in the first half of fiscal 2018.

Selling expenses

Selling expenses increased by $2.0 million, or 27.3% to $9.5 million in the first half of fiscal 2019 from $7.5 million in the prior year period. The increase is principally related to higher compensation costs and travel related expenses resulting from the continued buildout of the Company’s direct sales force, along with higher trade show and sales training expenses.

General and administrative expenses

General and administrative expenses increased by $0.6 million, or 11.6% to $5.5 million in the first half of fiscal 2019 from $5.0 million in the prior year period. This increase is principally related higher compensation and benefit expenses and a $150,000 severance charge.

Research and development expenses

Research and development expenses increased by $0.3 million or 15% to $2.1 million in the first half of fiscal 2019 from $1.9 million in the prior year period. The Company is investing in the design and development of its next generation platform product, Nexus, which is expected to be available in fiscal 2019. During the first half of fiscal 2019 and 2018, approximately $1.0 million and $ $1.1 million, respectively, was charged to research and development expenses related to this product.

Other income (expense)

Other income was $19,888 in the first half of fiscal 2019 compared with $0.5 million in the prior year period. This decrease related to the royalty income from MMIT in the prior year. This royalty agreement expired in August 2017.

Income taxes

For the six months ended December 31, 2018 and 2017, the Company recorded an income tax expense of $0 and 5,243,422, respectively. For the six months ended December 31, 2018 and 2017, the effective rate of 0% and 185.6%, respectively, varied from the U.S. federal statutory rate due to changes in the Company’s projected pretax book income.

The income tax expense for the first half of fiscal 2018 included a one-time charge of $1,764,039 to revalue the Company’s deferred tax assets as of December 31, 2017 to give effect to the reduction in corporate tax rates to 21% effective January 1, 2018, as a result of the Tax Cuts and Jobs Act of 2017, enacted on December 22, 2017. Income tax expense also includes a $3,988,532 charge to record a full valuation allowance against the Company’s remaining deferred tax assets. In accordance with the guidance of ASC Topic 740, management concluded that in its judgment, the Company’s deferred tax assets at December 31, 2017 are not more likely-than-not realizable. The components of the tax provision are as follows:

Six months ended December 31, 2017 and 2016

Our revenue by categoryIncome tax expense for the six months ended December 31, 2017 and 2016 are as follows:

Revenue

Revenue increased 27.9% or $3,402,563 to $15,604,568 in the first half of fiscal 2018 from $12,202,005 in fiscal 2017. Consumables revenue in the United States increased 21.8%, or $1,560,098 for the period, principally due to the strength in the Company’s BoneScalpel product line, which grew 36% during the first half of fiscal 2018. Domestic equipment revenue grew by 58.1% during the first half of fiscal 2018, resulting from strong SonaStar sales.

International revenue grew 32.2% during the first half of fiscal 2018, largely due to a 43% growth in SonaStar sales and a 18% growth in BoneScalpel sales.

Gross profit

Gross profit in the first half of fiscal 2018 was 70.2% of revenue, which increased from 69.4% in the first half of fiscal 2017. The increase resulted from a stronger mix of higher margin product.

Selling expenses

Selling expenses increased by $893,407, or 13.5% to $7,490,228 in the first half of fiscal 2018 from $6,596,821 in the prior year period. The increase is principally related to higher compensation costs resulting from the continued buildout of the Company’s direct sales force, along with higher commissions relating to the 27.9% increase in revenue.

General and administrative expenses

General and administrative expenses increased by $934,751, or 23.3% to $4,953,991 in the first half of fiscal 2018 from $4,019,240 in the prior year period. This increase is principally related to an increase of non-cash compensation expense for the first half of fiscal 2018 of $743,000 related to restricted stock and stock option grants to the Company’s board of directors and its current CEO. In addition, during the first half of fiscal 2017, the Company recorded a reduction in non-cash stock compensation expense of $805,000, which includes a reversal of stock compensation previously recognized on the Company’s prior CEO. Expense reductions for the first half of fiscal 2018 also included a reduction in professional fees of $460,000 and a reduction in accrued vacation of $153,000. The Company also incurred a charge of $330,000 in the first half of the prior year relating to severance for it former chief executive officer.

Research and development expenses

Research and development expenses increased by $926,030, or 99.3% to $1,858,478 in the first half of fiscal 2018 from $932,448 in the prior year period. The Company is investing in the design and development of its next generation product, which is expected to be available in fiscal 2019. For the first half of fiscal 2018, approximately $1.1 million has been charged to research and development expenses related to this product.

Other income (expense)

Other income decreased by $1,368,784 to $515,734 in the first half of fiscal 2018 from $1,884,518 in the prior year period. The decrease is related to lower royalty income from MMIT. This royalty agreement expired in August 2017.

Income taxes

For the six months ended December 31, 2017 and 2016, the Company recorded an income tax expense (benefit) of $5,243,422 and ($56,000), respectively. For the six months ended December 31, 2017 and 2016, the effective rate of 185.6% and (4.7%), respectively, varied from the U.S. federal statutory rate due to changes in the Company’s projected pretax book income.

The income tax expense for the first half of fiscal 2018 included a one-time charge of $1,764,039 to revalue the Company’s deferred tax asset as of December 31, 2017 to give effect to the reduction in corporate tax rates to 21% effective January 1, 2018, as a result of the Tax Legislation, enacted on December 22, 2017. Income tax expense also includes a $3,988,532 charge to record a full$655,000 valuation allowance against the Company’s remaining deferred tax assets.assets recorded in the quarter. In accordance with the guidance of ASC Topic 740, management concluded that in its judgment, the Company’s deferred tax assets at December 31, 20172018 are not more likely-than-not realizable. The components of the tax provision are as follows: