Inventories
Inventories
are stated at the lower of cost (first-in, first-out basis) or market.
We reduce inventory for estimated obsolete or
unmarketable inventory equal to the difference between the cost of inventory
and the estimated market value based upon assumptions about future demand and
market conditions. If actual market conditions are less favorable than those
projected by management, additional inventory write-downs may be required. I
nventory
consisted of the following:
|
|
December 31,
|
|
March 31,
|
|
|
|
2007
|
|
2007
|
|
|
|
|
|
|
|
Raw materials
|
|
$
|
1,095,715
|
|
$
|
1,166,607
|
|
Finished goods
|
|
1,061,020
|
|
677,620
|
|
|
|
2,156,735
|
|
1,844,227
|
|
Less - Reserve for obsolescence
|
|
(65,000
|
)
|
(80,000
|
)
|
|
|
$
|
2,091,735
|
|
$
|
1,764,227
|
|
Accrued Liabilities
We
have accrued $75,000 related to warranty claims, $107,828 related to sales
commissions and $68,852 related to rent normalization and have included these
amounts in accrued liabilities in the accompanying condensed balance sheet as
of December 31, 2007. We have accrued $100,000 related to warranty claims,
$136,128 related to sales commissions and $96,822 related to rent normalization
and have included these amounts in accrued liabilities in the accompanying
condensed balance sheet as of March 31, 2007.
Property and Equipment
Property
and equipment are stated at cost, with depreciation computed over the estimated
useful lives of the assets, generally three to seven years. Prior to fiscal
year 2008, we utilized the double-declining method of depreciation for property
and equipment due to the expected usage of the property and equipment over
time. We expect to continue using this method throughout the life of such
equipment. Manufacturing and production equipment acquired, but not
depreciated, in fiscal year 2007 and manufacturing and production equipment
acquired after fiscal year 2007 are technologically different, and, as a
result, since April 1, 2007 we have utilized, and will continue to utilize
the straight-line method of depreciation for this and other property and
equipment. This difference in depreciation methods utilized for manufacturing
and production equipment is based on the technological differences of the
equipment and does not constitute a change in accounting principles.
Income Taxes
The
provision for income taxes is based on our estimated annualized effective tax
rate for the year. Effective April 1, 2007, we adopted the provisions of
FASB Interpretation No. 48 (FIN 48), Accounting for Uncertainty in
Income Taxes An Interpretation of FASB Statement No. 109. FIN 48
provides detailed guidance for the financial statement recognition, measurement
and disclosure of uncertain tax positions recognized in the financial
statements in accordance with SFAS No. 109. Tax positions must meet a more-likely-than-not
recognition threshold at the effective date to be recognized upon the adoption
of FIN 48 and in subsequent periods. Upon the adoption of FIN 48, we had no unrecognized
tax benefits. During the third quarter of 2007, we recognized no adjustments
for uncertain tax benefits.
Deferred
income tax assets are adjusted by a valuation allowance, if necessary, to
recognize future tax benefits only to the extent, based on available evidence,
it is more likely than not such benefits will be realized. We recognize
interest and penalties, if any, related to uncertain tax positions in general
and administrative expenses. No interest or penalties related to uncertain tax
positions were accrued at December 31, 2007. We expect no material changes
to unrecognized tax positions within the next twelve months.
Research and Development
Expenses
We
expense research and development costs for products and processes as incurred.
Stock-Based Compensation Expense
On
April 1, 2006, we adopted Statement of Financial Accounting Standards 123
(revised 2004), Share-Based Payment (SFAS 123(R)), which requires the
measurement and recognition of compensation expense for all share-based payment
awards made to employees and directors, including employee stock options based
on estimated fair values. SFAS 123(R) supersedes our previous accounting
under Accounting Principles Board Opinion 25, Accounting for Stock Issued to
Employees (APB 25) for periods beginning in fiscal year 2007. In March 2005,
the Securities and Exchange Commission issued Staff Accounting Bulletin 107 (SAB
107) relating to SFAS 123(R). We have applied the provisions of SAB 107 in our
adoption of SFAS 123(R).
We
have adopted SFAS 123(R) using the modified prospective transition method,
which requires the application of the accounting standard as of April 1,
2006, the first day of our fiscal year 2007. Our financial statements as of and
for the three and nine months ended December 31, 2007 and December 31,
2006 reflect the impact of SFAS 123(R). In accordance with the modified
prospective transition method, our financial statements for prior periods have
not been restated to reflect, and do not include, the impact of SFAS 123(R).
Stock-based compensation expense recognized under SFAS 123(R) for the
three and nine months ended December 31, 2007 was $36,340 and $111,554,
respectively, which consisted of stock-based compensation expense related to
employee stock options. Stock-based compensation expense related to employee
stock options during the three and nine months ended December 31, 2006 was
$43,885 and $138,539, respectively.
SFAS
123(R) requires companies to estimate the fair value of share-based
payment awards on the date of grant using an option-pricing model. The value of
the portion of the award that is ultimately expected to vest is recognized as
expense over the requisite service periods in our Statement of
8
Operations.
Prior to the adoption of SFAS 123(R), we accounted for stock-based awards to
employees and directors using the intrinsic value method in accordance with APB
25, as allowed under Statement of Financial Accounting Standards 123, Accounting
for Stock-Based Compensation (SFAS 123). Under the intrinsic value method we
did not recognize stock-based compensation expense in our Statements of
Operations because the exercise price of our stock options granted to employees
and directors equaled the fair market value of the underlying stock at the date
of grant.
Stock-based
compensation expense recognized during the period is based on the value of the
portion of share-based payment awards that is ultimately expected to vest
during the period. The stock-based compensation expense recognized in our
Statement of Operations for the third quarter of fiscal year 2008 included
compensation expense for share-based payment awards granted prior to, but not
yet vested as of December 31, 2007, based on the grant date fair value
estimated in accordance with the pro forma provisions of SFAS 123 and the
compensation expense for the share-based payment awards granted subsequent to July 30,
2005, which are also based on the grant date fair value estimated in accordance
with the provisions of SFAS 123(R). Compensation expense for all share-based
payment is recognized using the straight-line, single-option method. As
stock-based compensation expense recognized in the Statements of Operations for
the third quarter of fiscal year 2008 is based on awards ultimately expected to
vest, it has been reduced for estimated forfeitures. SFAS 123(R) requires
forfeitures to be estimated at the time of grant and revised, if necessary, in
subsequent periods if actual forfeitures differ from those estimates. In our
pro forma information required under SFAS 123 for the periods prior to fiscal
year 2007, we accounted for forfeitures as they occurred.
Upon
adoption of SFAS 123(R), we continued to use the Black-Scholes option-pricing
model (Black-Scholes model) which we previously used for our pro forma
information required under SFAS 123. Our determination of fair value of
share-based payment awards on the date of grant using an option-pricing model
is affected by our stock price as well as assumptions regarding a number of
highly complex and subjective variables. These variables include, but are not
limited to, our expected stock price volatility over the term of the awards and
actual and projected employee stock option exercise behaviors. Although the
fair value of employee stock options is determined in accordance with SFAS 123(R) and
SAB 107 using an option-pricing model, that value may not be indicative of the
fair value observed in a willing buyer/willing seller market transaction.
On
November 10, 2005, the Financial Accounting Standards Board (FASB)
issued FASB Staff Position FAS 123(R)-3 Transition Election Related to
Accounting for Tax Effects of Share-Based Payment Awards. We have elected to
adopt the alternative transition method provided in the FASB Staff Position for
calculating the tax effects of stock-based compensation pursuant to SFAS
123(R). The alternative transition method includes simplified methods to
establish the beginning balance of the additional paid-in capital pool (APIC
pool) related to the tax effects of employee stock-based compensation and to
determine the subsequent impact on the APIC pool and Statements of Cash Flows
of the tax effects of employee stock-based compensation awards that are
outstanding upon adoption of SFAS 123(R).
Segment Reporting
We
have concluded that we have one operating segment.
Basic and Diluted Income and
Loss per Common Share
Net
income or loss per share is calculated in accordance with SFAS 128, Earnings
Per Share (SFAS 128). Under the provisions of SFAS 128, basic net income or
loss per common share is computed by dividing net income or loss for the period
by the weighted average number of common shares outstanding for the period.
Diluted net income or loss per common share is computed by dividing the net
income or loss for the period by the weighted average number of common and
potential common shares outstanding during the period, if the effect of the
potential common shares is dilutive.
For
the three and nine month periods ended December 31, 2007, we had
currently-exercisable stock options outstanding that could create future
dilution to our common shareholders but are not currently classified as
outstanding common shares. Our common stock number is based on specific conversion
or issuance assumptions pursuant to the corresponding terms of each instrument.
The
following table presents the calculation of basic and diluted net income or
loss per share:
|
|
Three Months Ended
|
|
Nine Month Ended
|
|
|
|
December 31,
2007
|
|
December 31,
2006
|
|
December 31,
2007
|
|
December 31,
2006
|
|
Net income (loss)
|
|
$
|
59,036
|
|
$
|
(49,058
|
)
|
$
|
(228,486
|
)
|
$
|
86,692
|
|
Weighted-average shares basic
|
|
6,447,100
|
|
6,430,437
|
|
6,439,527
|
|
6,420,280
|
|
Effect of dilutive potential common shares
|
|
3,609
|
|
|
|
|
|
14,424
|
|
Weighted-average shares diluted
|
|
6,450,709
|
|
6,430,437
|
|
6,439,527
|
|
6,434,704
|
|
Net income (loss) per share basic
|
|
$
|
0.01
|
|
$
|
(0.01
|
)
|
$
|
(0.04
|
)
|
$
|
0.01
|
|
Net income (loss) per share diluted
|
|
$
|
0.01
|
|
$
|
(0.01
|
)
|
$
|
(0.04
|
)
|
$
|
0.01
|
|
Antidilutive employee stock options
|
|
381,391
|
|
440,000
|
|
385,000
|
|
425,576
|
|
(3)
COMMITMENTS AND
CONTINGENCIES
We
currently lease our facilities located at 6797 Winchester Circle, Boulder,
Colorado under noncancelable lease agreements through August 14, 2009. The
minimum future lease payments as of December 31, 2007, by fiscal year, are
as follows:
Fiscal Year
|
|
Amount
|
|
2008 (remaining three months)
|
|
$
|
60,343
|
|
2009
|
|
249,691
|
|
2010
|
|
94,804
|
|
|
|
$
|
404,838
|
|
9
ITEM 2
-
MANAGEMENTS
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Certain statements contained in this section on Managements Discussion
and Analysis are not historical facts, including statements about our
strategies and expectations with respect to new and existing products, market
demand, acceptance of new and existing products, marketing efforts,
technologies and opportunities, market and industry segment growth, and return
on investments in products and markets. These statements are forward looking
statements within the meaning of the Private Securities Litigation Reform Act
of 1995 and involve substantial risks and uncertainties that may cause actual
results to differ materially from those indicated by the forward looking
statements. All forward looking statements in this section on Managements
Discussion and Analysis are based on information available to us on the date of
this document, and we assume no obligation to update such forward looking
statements. Readers of this Form 10-QSB are strongly encouraged to review
the section entitled
Risk Factors
in
our Form 10-KSB for the year ended March 31, 2007.
General
Encision
Inc., a medical device company based in Boulder, Colorado, has developed and
launched innovative technology that is emerging as a standard of care in
minimally-invasive surgery. We believe that our patented AEM
®
Surgical Instruments are changing the marketplace for electrosurgical devices
and laparoscopic instruments by providing a solution to a well documented
patient safety risk in laparoscopic surgery.
We
were founded to address market opportunities created by the increase in
minimally-invasive surgery (MIS) and surgeons preference for using
electrosurgery devices in these procedures. The product opportunity was created
by surgeons continued widespread demand for using monopolar electrosurgery
instruments, which, when used in laparoscopic surgery, are susceptible to
causing inadvertent collateral tissue damage outside the surgeons field of
view. The risk of unintended electrosurgical burn injury to the patient in
laparoscopic surgery has been well documented. This risk poses a threat to
patient safety and creates liability exposure for surgeons and hospitals that
do not adequately address the issue.
Our
patented AEM technology provides surgeons with the desired tissue effects,
while preventing stray electrosurgical energy that can cause unintended and
unseen tissue injury. AEM Laparoscopic Instruments are equivalent to
conventional instruments in functionality, but they incorporate active
electrode monitoring technology to dynamically and continuously monitor the
flow of electrosurgical current, thereby helping to prevent patient injury.
With our shielded and monitored instruments, surgeons are able to perform
electrosurgical procedures more safely and effectively than when using
conventional instruments. In addition, our AEM instruments are cost competitive
with conventional non-shielded, non-monitored instruments. The result is
advanced patient safety at comparable cost and with no change in surgeon
technique.
AEM
technology has been recommended and endorsed by sources from all groups
involved in minimally-invasive surgery. Surgeons, nurses, biomedical engineers,
the medicolegal community, malpractice insurance carriers and electrosurgical
device manufacturers advocate the use of AEM technology. Recommendations from
the malpractice insurance and medicolegal communities complement the broad
clinical endorsements AEM technology has garnered over the past few years.
Adding
further credibility to the benefits of our AEM technology are our supplier
agreements with Novation and Premier, two of the largest Group Purchasing
Organizations (GPOs) in the United States. Together, Novation and Premier
represent over 3,000 hospitals which perform over 50% of all surgery in the
U.S. We believe that these GPO supplier agreements give further indication that
AEM technology is gaining broader acceptance in the market. We believe that
having the nations leading medical purchasing groups recognize the value of
our technology reflects the potential impact that AEM products can have in the
market and in advancing patient safety in surgery nationwide. These agreements
do not involve purchase commitments, but we expect these relationships to
expand the market visibility of AEM technology and to ease the procurement
process for new hospital customers.
We
have focused our marketing strategies to date on expanding the market awareness
of the AEM technology and our broad independent endorsements and have continued
efforts to improve and expand the AEM product line. Accordingly, we are
currently focusing on modernizing our accepted AEM instruments to include
ergonomics and user functionalities for which surgeons have been expressing a
preference. During fiscal year 2006, we announced
enTouch
, an ergonomically-designed handle for our articulating
instruments, and we plan to introduce new additions to the AEM product line in
fiscal year 2008.
When
a hospital changes to AEM technology, we receive recurring sales from sales of
replacement instruments. We believe that there is no directly competing
technology to supplant AEM products once a hospital switches to our products.
The replacement market of reusable and disposable AEM products in hospitals
that use our AEM technology represented over 90% of our sales over the past
three months. This sales stream is expected to grow as the base of hospitals
that switch to AEM technology continues to grow. In addition, we intend to
develop disposable versions of more of our AEM products in order to meet market
demands and expand our sales opportunities.
We
achieved profitable operations in fiscal years 2004 and 2003. However, in each
fiscal year prior to 2003 and in fiscal years 2005, 2006 and 2007, we incurred
losses and had an accumulated deficit of $16,507,774 at December 31, 2007.
Operations have been financed primarily through the issuance of our common
stock.
During
the nine months ended December 31, 2007, we used $157,582 of cash in our
operations and used $464,030 for investments in equipment. As of December 31,
2007, we had $98,908 in cash and cash equivalents available to fund future
operations, a decrease of $337,495 from March 31, 2007. As of December 31,
2007, we have borrowed $280,000 from our credit facility. Our working capital
was $1,768,204 at December 31, 2007.
Historical Perspective
We were organized in 1991 and spent several years
developing the AEM monitoring system and protective sheaths to adapt to
conventional electrosurgical instruments. During this period, we conducted product
trials and applied for patents with the United States Patent Office and
international patent agencies. Patents were issued to us in 1994, 1996, 1997,
1998 and 2002.
As
we evolved, it became clear to us that our AEM technology needed to be
integrated into the standard laparoscopic instrument design. As the development
program proceeded, it also became apparent that the merging of electrical and
mechanical engineering skills in the instrument
11
development
process for our patented, integrated electrosurgical instruments was a complex
and difficult task. As a result, instruments with integrated AEM technology
were not completed for several years. Prior to offering a full range of
laparoscopic electrosurgical instrumentation, it was difficult for hospitals to
commit to the AEM solution, as we did not have adequate comparable surgical
instrument options to match what surgeons demanded. As of fiscal year 2001, a
sufficiently broad product line was available to provide hospital operating
rooms with AEM instruments in most of the designs common for laparoscopic
surgery.
The launch of an expanded line of AEM instruments was accomplished over
the past two years. We are now turning our focus to developing next generation
versions of our AEM instruments to better meet market demands, particularly the
demand for improved ergonomics and simplified user functionalities. This
strategy coincides with the independent endorsements of our AEM technology.
Recommendations from the malpractice insurance and medicolegal communities
complement the broad clinical endorsements that AEM technology has garnered
over the past few years.
Outlook
Installed
Base of AEM Monitoring Equipment
: We believe that the installed base of AEM monitors
has the potential for increasing sales as the inherent risks associated with
monopolar laparoscopic electrosurgery become more widely acknowledged and as we
focus on increasing our sales efficiency. We expect that the replacement sales
of electrosurgical instruments and accessories will increase as additional
hospitals adopt AEM technology. We anticipate that the efforts to improve the
quality of sales representatives carrying the AEM product line, along with
increased marketing efforts and the introduction of next generation products,
may provide the basis for increased sales and maintaining profitable
operations. However, these measures, or any others that we may adopt, may not
result in either increased sales or maintaining profitable operations.
Furthermore, most of our next generation products are in the early stages of
development.
F
urther additions to the
AEM product line are planned for introduction in fiscal year 2008.
We
believe that the unique performance of the AEM technology and our breadth of
independent endorsements provide an opportunity for continued market share
growth. In our view, market awareness and awareness of the clinical credibility
of the AEM technology, as well as awareness of our endorsements, are
continually improving, and we expect this awareness to benefit our sales
efforts for the remainder of fiscal year 2008. Our objectives in the remainder
of fiscal year 2008 is to maintain expense controls while optimizing sales
execution in the field, to expand market awareness of the AEM technology and to
maximize the number of additional hospital accounts switching to AEM
instruments while retaining existing hospital customers. In addition,
acceptance of AEM products depends on surgeons preference for our instruments,
which depends on factors such as ergonomics and ease of use in addition to the
technological advantage of AEM products. If surgeons prefer other instruments
to our instruments, our business results will suffer.
Possibility
of Operating Losses
: We achieved
profitable operations in fiscal years 2004 and 2003. However, in each fiscal
year prior to 2003 and in fiscal years 2005, 2006 and 2007, we incurred losses
and had an accumulated deficit of $16,507,774 at December 31, 2007. We
have made strides toward improving our operating results. Due to the ongoing
need to develop, optimize and train the direct sales managers and the
independent sales representative network, the need to support the development
of refinements to our product line, and the need to increase sustained sales to
a level adequate to cover fixed and variable operating costs, we may operate at
a net loss from time to time. Sustained losses, or our inability to generate
sufficient cash flow from operations to fund our obligations, may result in a
need to raise additional capital.
Sales
Growth
: We expect to generate increased
sales in the U.S. from sales to new hospital customers and from expanded sales
in existing hospitals as our network of direct and independent sales
representatives becomes more efficient. We believe that the visibility and
credibility of the independent clinical endorsements for AEM technology will
contribute to new hospital accounts and increase sales in fiscal year 2008
.
We also expect that supplier agreements
with Novation and Premier, which together represent over 3,000 U.S. hospitals,
will expose more hospitals to the benefits of AEM technology and may stimulate
new hospital accounts. We also expect to increase market share through
promotional programs of placing our AEM monitors at no charge into hospitals
that commit to standardize AEM instruments. However, all of these efforts to
increase market share and grow sales will depend in part on our ability to
expand the efficiency and effective coverage range of our direct and independent
sales representatives.
We
also have longer term initiatives in place to improve our prospects. We expect that development of next generation
versions of our AEM products will better position our products in the
marketplace and improve our retention rate at hospitals that have changed to
AEM technology, enabling us to grow our sales.
We may also explore overseas markets to assess opportunities for sales
growth internationally.
Finally, we intend to explore opportunities to
capitalize on our proven AEM technology via licensing arrangements and
strategic alliances. These efforts to generate additional sales and further the
market penetration of our products are longer term in nature and may not
materialize. Even if we are able to successfully develop next generation
products or identify potential international markets or strategic partners, we
may not be able to capitalize on these opportunities.
Gross
Profit and Gross Margins
: Gross
profit and gross margins can be expected to fluctuate from quarter to quarter
as a result of product sales mix and sales volume. Gross margins on products
manufactured or assembled by us are expected to improve at higher levels of
production and sales.
Manufacturing
Equipment.
We expect to
increase gross profit and gross margins from manufacturing our scissor inserts
internally. We began manufacturing our scissor inserts in the third quarter of
fiscal year 2008.
Sales
and Marketing Expenses
: We continue our efforts to expand domestic
and international distribution capability, and
we believe that sales and marketing expenses will decrease as a percentage of
net sales with increasing sales volume.
Research
and Development Expenses
:
Research
and development expenses are expected to increase modestly to support
development of refinements to our AEM product line, which will further expand
the instrument options for surgeons.
Results of Operations
For the
three months ended December 31, 2007 compared to the three months ended December 31,
2006.
12
Net sales.
Net sales for the quarter ended December 31, 2007, was $3,130,752
compared to $2,787,147 for the quarter ended December 31, 2006, an
increase of 12%. The increase is attributable to the addition of new hospital
accounts, partially offset by business lost from hospitals that previously
changed to AEM technology. We opened nine new hospital accounts for AEM
technology in the three months ended December 31, 2007 versus nine new
hospital accounts for AEM technology in the three months ended December 31,
2006. We have changed and added new sales managers and independent sales
representatives in an effort to capitalize on identified market opportunities.
It will take a number of months before new sales managers and new independent sales
representatives generate new hospital accounts, but we expect that the
combination of these new additions will provide the focus that is needed to
achieve market gains.
Gross profit
. Gross profit for
the quarter ended December 31,
2007 of $2,027,567 represented an increase of 17% from gross profit of
$1,732,839 for the quarter ended December 31, 2006. Gross profit as a
percentage of sales (gross margins) increased from 62% for the quarter ended December 31,
2006 to 65% for the quarter ended December 31, 2007. This years quarter
ended December 31, 2007 included an approximately 1% increase in gross
margin that was attributed to a decrease in accrued liabilities related to
warranty claims.
Sales and marketing expenses
. Sales and marketing expenses of $1,304,732
for the quarter ended December 31, 2007 represented an increase of 18%
from sales and marketing expenses of $1,105,251 for the quarter ended December 31,
2006.
The increase was a result of increased
compensation for additional sales employees and increases in sales samples and
travel expenses. The increase in such cost was partially offset by decreased
commissions for independent sales representatives.
General and administrative expenses
. General and administrative expenses of
$330,777 for the quarter ended December 31, 2007 represented a decrease of
13% from general and administrative expenses of $378,359 for the quarter ended December 31,
2006. The decrease was primarily the result of last years quarter ended December 31,
2006 one-time expense of approximately $73,000 relating to the costs of
obtaining equity capital financing, a project that was subsequently abandoned
after we obtained a $2,000,000 line of credit facility from SVB Silicon Valley
Bank. The decrease in expenses during the quarter ended December 31, 2007
was partially offset by increased compensation and outside services. Excluding
the one-time expense of approximately $73,000 during the quarter ended December 31,
2006, general and administrative expenses for the quarter ended December 31,
2007 increased 8% from the quarter ended December 31, 2006.
Research and development expenses
. Research and development expenses of $325,028
for the quarter ended December 31, 2007 represented an increase of 5%
compared to $310,083 for the quarter ended December 31, 2006. The increase
was a result of compensation and inventory and test material usage.
Net
income.
Net income was $59,036 for
the quarter ended December 31, 2007 compared to net loss of $49,058 for
the quarter ended December 31, 2006. Net income was a result of increased
sales income that was partially reduced by increased operating expenses.
For the
nine months ended December 31, 2007 compared to the nine months ended December 31,
2006.
Net sales.
Net sales for the nine months ended December 31, 2007, was
$8,882,413 compared to $8,192,800 for the nine months ended December 31,
2006, an increase of 8%. The increase is attributable to the decrease in
hospitals orders for reusable instruments compared to orders placed one year ago
and the addition of new hospital accounts, partially offset by business lost
from hospitals that previously changed to AEM technology. We opened 30 new
hospital accounts for AEM technology in the nine months ended December 31,
2007 versus 30 new hospital accounts for AEM technology in the nine months
ended December 31, 2006. We have changed and added new sales managers and
independent sales representatives in an effort to capitalize on identified
market opportunities. It will take a number of months before new sales managers
and new independent sales representatives generate new hospital accounts, but
we expect that the combination of these new additions will provide the focus
that is needed to achieve market gains.
Gross profit
. Gross profit for
the nine months ended December 31,
2007 of $5,581,822 represented an increase of 9% from gross profit of
$5,137,389 for the nine months ended December 31, 2006. Gross profit as a
percentage of sales (gross margins) was 63% for both the nine months ended December 31,
2007 and the nine months ended December 31, 2006.
Sales and marketing expenses
. Sales and marketing expenses of $3,755,460
for the nine months ended December 31, 2007 represented an increase of 16%
from sales and marketing expenses of $3,248,336 for the nine months ended December 31,
2006.
The increase was a result of increased
compensation for additional sales employees and increases in sales samples and
travel expenses. The increase in such cost was partially offset by decreased
commissions for independent sales representatives.
General and administrative expenses
. General and administrative expenses of
$1,053,022 for the nine months ended December 31, 2007 represented a small
decrease from general and administrative expenses of $1,056,473 for the nine
months ended December 31, 2006. The decrease was primarily the result of
last years quarter ended December 31, 2006 one-time expense of
approximately $73,000 relating to the costs of obtaining equity capital
financing, a project that was subsequently abandoned after we obtained a
$2,000,000 line of credit facility from SVB Silicon Valley Bank. The decrease
in expenses was offset by increased compensation, legal fees and outside
services. Excluding last years quarter one-time expense of approximately $73,000,
general and administrative expenses for the nine months ended December 31,
2006 increased 7% from the nine months ended December 31, 2006.
Research and development expenses
. Research and development expenses of $988,659
for the nine months ended December 31, 2007 represented an increase of 26%
compared to $784,313 for the nine months ended December 31, 2006. The
increase was a result of compensation of employing additional engineers,
outside services and test or prototype materials.
Net
income or loss.
Net loss was
$228,486 for the nine months ended December 31, 2007 compared to net
income of $86,692 for the nine months ended December 31, 2006. Net loss
was a result of an increase in sales that was offset by increased operating
expenses.
13
Liquidity and Capital Resources
To
date, operating funds have been provided primarily by sales of our common stock
and of warrants to purchase our common stock, which together totaled
$19,360,079 through December 31, 2007, and, to a lesser degree, by funds
provided by sales of our products.
On
November 10, 2006, we entered into a credit facility agreement with
Silicon Valley Bank. The terms of the credit facility include a line of credit
for $2,000,000 for three years at an interest rate calculated at prime rate
plus 1.25%. In connection with the credit facility, we issued warrants to
Silicon Valley Bank to purchase 28,000 shares of our common stock at a per
share price of $2.75. Our borrowing under the credit facility is limited by our
eligible receivables and inventory at the time of borrowing. As of December 31,
2007, we have borrowed $280,000 from this facility.
Our
operations used $157,582 of cash in the
nine
months
ended December 31, 2007 on net sales of $8,882,413. Prior to
fiscal year 2003 and in fiscal years 2005, 2006 and 2007, the use of cash in
our operations resulted primarily from the funding of annual net losses. These
amounts of cash generated from and used in operations are not indicative of the
expected cash to be generated from or used in operations in fiscal year 2008.
For the nine months ended December 31, 2007, we invested $464,030 in the
acquisition of property and equipment. As of December 31, 2007, we had
$98,908 in cash and cash equivalents available to fund future operations and have
borrowed $280,000 from our credit facility. Working capital was $1,768,204 at December 31,
2007 compared to $2,172,722 at March 31, 2007. Current liabilities were
$1,774,767 at December 31, 2007, compared to $1,464,153 at March 31,
2007.
If
we are not successful in obtaining profitability and positive cash flow,
additional capital may be required to maintain ongoing operations. We have
explored and are continuing to explore options to provide additional financing
to fund future operations as well as other possible courses of action. Such
actions include, but are not limited to, securing further lines of credit,
sales of debt or equity securities (which may result in dilution to existing
shareholders), licensing of technology, strategic alliances and other similar
actions. There can be no assurance that we will be able to obtain additional
funding (if needed), on acceptable terms or at all, through a sale of our
common stock, loans from financial institutions or other third parties, or any
of the actions discussed above. If we cannot sustain profitable operations, and
additional capital is unavailable, lack of liquidity could have a material
adverse effect on our business viability, financial position, results of
operations and cash flows.
We
currently lease our facilities located at 6797 Winchester Circle, Boulder,
Colorado under noncancelable lease agreements through August 14, 2009. The
minimum future lease payments as of December 31, 2007, by fiscal year, are
as follows:
Fiscal Year
|
|
Amount
|
|
2008 (remaining three months)
|
|
$
|
60,343
|
|
2009
|
|
249,691
|
|
2010
|
|
94,804
|
|
|
|
$
|
404,838
|
|
Our minimum future equipment lease payments with
General Electric Capital Corporation as of December 31, 2007, by fiscal
year, are as follows:
Fiscal Year
|
|
Amount
|
|
2008 (remaining three months)
|
|
$
|
25,469
|
|
2009
|
|
101,873
|
|
2010
|
|
101,873
|
|
2011
|
|
101,873
|
|
2012
|
|
101,873
|
|
2013
|
|
101,873
|
|
2014
|
|
8,488
|
|
|
|
$
|
543,322
|
|
Our
fiscal year 2008 operating plan is focused on increasing new hospital accounts,
retaining existing hospital customers, growing sales, increasing gross profits
and conserving cash. We are investing in research and development efforts to
develop next generation versions of the AEM product line. We are also investing
in manufacturing property and equipment to manufacture disposable scissors
inserts internally and reduce our cost of sales. We cannot predict with
certainty the expected sales, gross profit, net income or loss and usage of
cash and cash equivalents for fiscal year 2008. However, we believe that our
cash resources and credit facility will be sufficient to fund our operations
for at least the next twelve months. If we are unable to manage our business
operations in line with budget expectations, it could have a material adverse
effect on our business viability, financial position, results of operations and
cash flows. If we are not successful in achieving profitability and positive
cash flow, additional capital may be required to maintain ongoing operations.
Income Taxes
As
of March 31, 2007, net operating loss carryforwards totaling approximately
$16,400,000 are available to reduce taxable income in the future. The net
operating loss carryforwards expire, if not previously utilized, at various
dates beginning in the fiscal year ended March 31, 2008. We have not paid
income taxes since our inception. The Tax Reform Act of 1986 and other income
tax regulations contain provisions which may limit the net operating loss
carryforwards available to be used in any given year if certain events occur,
including changes in ownership interests. We have established a valuation
allowance for the entire amount of our deferred tax asset since inception due
to our history of losses. Should we achieve sufficient, sustained income in the
future, we may conclude that some or all of the valuation allowance should be
reversed. If some or all of the valuation allowance were reversed, then, to the
extent of the reversal, a tax benefit would be recognized which would result in
an increase to income.
Critical Accounting Policies and Estimates
Our discussion and analysis of our financial condition
and results of operations are based upon our financial statements, which have
been prepared in accordance with accounting principles generally accepted in
the United States. The preparation of these financial statements requires us to
make estimates
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and judgments that affect the reported amounts of assets,
liabilities, sales and expenses, and related disclosure of contingent assets
and liabilities. On an on-going basis, we evaluate our estimates, including
those related to bad debts, inventories, sales returns, warranty, contingencies
and litigation. We base our estimates on historical experience and on various
other assumptions that are believed to be reasonable under the circumstances,
the results of which form the basis for making judgments about the carrying
values of assets and liabilities that are not readily apparent from other
sources. Actual results may differ from these estimates under different
assumptions or conditions. We believe the following critical accounting
policies affect the more significant judgments and estimates used in the
preparation of our financial statements.
We maintain allowances for doubtful accounts for estimated
losses resulting from the inability of our customers to make required payments.
If the financial condition of our customers were to deteriorate, resulting in
an impairment of their ability to make payments, additional allowances would be
required, which would increase our expenses during the periods in which any
such allowances were made. The amount recorded as a provision for bad debts in
each period is based upon our assessment of the likelihood that we will be paid
on our outstanding receivables, based on customer-specific as well as general
considerations. To the extent that our estimates prove to be too high, and we
ultimately collect a receivable previously determined to be impaired, we may
record a reversal of the provision in the period of such determination.
We provide for the estimated cost of product warranties
at the time sales is recognized. While we engage in extensive product quality
programs and processes, including actively monitoring and evaluating the
quality of our component suppliers, we have experienced some costs related to
warranty. The warranty accrual is based upon historical experience and is
adjusted based on current experience. Should actual warranty experience differ
from our estimates, revisions to the estimated warranty liability would be
required.
We reduce inventory for estimated obsolete or
unmarketable inventory equal to the difference between the cost of inventory
and the estimated market value based upon assumptions about future demand and
market conditions. If actual market conditions are less favorable than those
projected by management, additional inventory write-downs may be required. Any
write-downs of inventory would reduce our reported net income during the period
in which such write-downs were applied. To the extent that our estimates prove
to be too high, and we ultimately utilize or sell inventory previously
determined to be impaired, we may record a reversal of the provision in the
period of such determination.
We
recognize deferred income tax assets and liabilities for the expected future
income tax consequences, based on enacted tax laws, of temporary differences
between the financial reporting and tax bases of assets and liabilities.
Deferred tax assets are then reduced, if deemed necessary, by a valuation
allowance for the amount of any tax benefits which, more likely than not based
on current circumstances, are not expected to be realized. Should we achieve
sufficient, sustained income in the future, we may conclude that all or some of
the valuation allowance should be reversed.
Property
and equipment are stated at cost, with depreciation computed over the estimated
useful lives of the assets, generally three to seven years. Prior to fiscal
year 2008, we utilized the double-declining method of depreciation for property
and equipment due to the expected usage of the property and equipment over
time. This method is expected to continue throughout the life of the equipment.
Manufacturing and production equipment acquired, but not depreciated, in fiscal
year 2007 and manufacturing and production equipment acquired after fiscal 2007
is a different technology and we will utilize the straight-line method of
depreciation for this and other property and equipment starting April 1,
2007. This difference in depreciation methods utilized for manufacturing and
production equipment is based on the technological differences of the equipment
and does not constitute a change in accounting principle. Maintenance and
repairs are expensed as incurred and major additions, replacements and
improvements are capitalized.
We amortize our patent costs over their estimated useful
lives, which is typically the remaining statutory life. From time to time, we
may be required to adjust these lives based on advances in technology, competitor
actions, and the like. We review the recorded amounts of patents at each period
end to determine if their carrying amount is still recoverable based on our
expectations regarding sales of related products. Such an assessment, in the
future, may result in a conclusion that the assets are impaired, with a
corresponding charge against earnings.
We currently estimate forfeitures for stock-based
compensation expense related to employee stock options at 7% and evaluate the
forfeiture rate quarterly.
Recent Developments
On July 16, 2007, we received a letter from AMEX
stating that we were not in compliance with Section 1003(a)(ii) of
the Amex Company Guide due to stockholders equity of less than $4,000,000 and
losses from continuing operations and/or net losses in three out of four of its
most recent fiscal years. On August 15, 2007, we provided AMEX with
information regarding our plan of compliance and financial projections. Based
on a review of this information and conversations between AMEX Staff and our representatives,
AMEX agreed to extend the period by which we must regain compliance with its
listing standards to January 16, 2009. We will be subject to periodic
review by the AMEX Staff regarding our compliance plan during the extension
period. Failure to make progress consistent with the plan could result in
commencement of immediate delisting proceedings by AMEX.
Risk Factors
We
wish to caution you that there are risks and uncertainties that could cause our
actual results to be materially different from those indicated by forward
looking statements that we make from time to time in filings with the
Securities and Exchange Commission, news releases, reports, proxy statements,
registration statements and other written communications, as well as oral forward
looking statements made from time to time by our representatives. These risks
and uncertainties include, but are not limited to, those listed in our Annual
Report on Form 10-KSB for the year ended March 31, 2007. These risks
and uncertainties and additional risks and uncertainties not presently known to
us or that we currently deem immaterial may cause our business, financial
condition, operating results and cash flows to be materially adversely
affected. Except for the historical information contained herein, the matters
discussed in this analysis are forward looking statements that involve risks
and uncertainties, including but not limited to general business conditions and
other factors which are often beyond our control. We do not undertake any obligation
to update forward looking statements except as required by law.
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