# Apyx Medical Corp: Form 10-Q for the period ended Jun 30, 2010

- Company: [Apyx Medical Corp](/companies/apyx.md) (CIK 719135)
- Form: 10-Q
- Filed: 2010-08-09
- Accepted by EDGAR: Aug 9, 2010, 06:42 ET
- Period: 2010-06-30
- Accession: 0001140361-10-032168
- Inline XBRL: no
- Main document: https://www.sec.gov/Archives/edgar/data/719135/000114036110032168/form10q.htm
- All documents and exhibits: https://www.sec.gov/Archives/edgar/data/719135/000114036110032168/

## Management's discussion and analysis

As filed, 39,903 characters.

### Cautionary Notes Regarding “Forward-Looking” Statements

This report contains statements that we believe to be “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements give our current expectations or forecasts of future events. Forward-looking statements generally can be identified by the use of forward-looking terminology such as “may,” “will,” “expect,” “intend,” “estimate,” “anticipate,” “believe,” “project,” or “continue,” or similar words or the negative thereof. From time to time, we also may provide oral or written forward-looking statements in other materials we release to the public. Any or all of our forward-looking statements in this report and in any public statements we make could be materially different from actual results. They can be affected by assumptions we might make or by known or unknown risks or uncertainties. Consequently, we cannot guarantee any forward-looking statements. Investors are cautioned not to place undue reliance on any forward-looking statements. Investors should also understand that it is not possible to predict or identify all such factors and should not consider the following list to be a complete statement of all potential risks and uncertainties. The following factors and those discussed in ITEM 1A, Risk Factors, included in our Annual Report on Form 10-K for the year ended December 31, 2009, may affect the achievement of forward-looking statements:

- general economic and political conditions, such as political instability, credit market uncertainty, the rate of economic growth or decline in our principal geographic or product markets or fluctuations in exchange rates; continued deterioration in or stabilization of the global economy;
- changes in general economic and industry conditions in markets in which we participate, such as:
- continued deterioration in or destabilization of the global economy;
- the strength of product demand and the markets we serve;
- the intensity of competition, including that from foreign competitors;
- pricing pressures;
- the financial condition of our customers;
- market acceptance of new product introductions and enhancements;
- the introduction of new products and enhancements by competitors;
- our ability to maintain and expand relationships with large customers;
- our ability to source raw material commodities from our suppliers without interruption and at reasonable prices; and
- our ability to source components from third parties, in particular from foreign manufacturers, without interruption and at reasonable prices;
- our ability to access capital markets and obtain anticipated financing under favorable terms;
- our ability to identify, complete and integrate acquisitions successfully and to realize expected synergies on our anticipated timetable;
- changes in our business strategies, including acquisition, divestiture and restructuring activities;
- changes in operating factors, such as continued improvement in manufacturing activities, the achievement of related efficiencies and inventory risks due to shifts in market demand;
- our ability to generate savings from our cost reduction actions;
- unanticipated developments that could occur with respect to contingencies such as litigation, intellectual property matters, product liability exposures and environmental matters; and
- our ability to accurately evaluate the effects of contingent liabilities.

The foregoing factors are not exhaustive, and new factors may emerge or changes to the foregoing factors may occur that would impact our business. We assume no obligation, and disclaim any duty, to update the forward-looking statements in this report. Past performance is no guaranty of future results.

### Overview

We are a medical device company engaged in the manufacturing and marketing of electrosurgical devices. Our medical products include a wide range of devices including electrosurgical generators and accessories, cauteries, medical lighting, nerve locators and other products.

We internally divide our operations into three product lines. Electrosurgical products, battery operated cauteries and other products. The electrosurgical line sells electrosurgical products which include desiccators, generators, electrodes, electrosurgical pencils and various ancillary disposable products. These products are used in surgery for the cutting and coagulation of tissue. Battery operated cauteries are used for precise hemostasis (to stop bleeding) in ophthalmology and in other fields. Our other revenues are derived from nerve locators, disposable and reusable penlights, medical lighting, license fees, development fees and other miscellaneous income.

Most of our products are marketed through medical distributors, which distribute to more than 6,000 hospitals, and to doctors and other health-care facilities. New distributors are contacted through responses to our advertising in international and domestic medical journals and domestic or international trade shows. International sales represented 22.0% of total revenues in for the first six months of 2010 as compared with 17.3% in for the first six months of 2009. Our products are sold in more than 150 countries through local dealers which are coordinated by sales and marketing personnel at the Clearwater, Florida facility. Our business is generally not seasonal in nature.

Our ten largest customers accounted for approximately 67% and 73% of net revenues for the first six months of 2010 and 2009 respectively. At June 30, 2010 and 2009, our ten largest trade receivables accounted for approximately 70% and 71% of our net receivables, respectively. In the first six months of 2010 and 2009 one customer accounted for 14% and 27% of total sales, respectively.

Our business is generally not seasonal in nature.

### Results of Operations –Three and Six Months Ended June 30, 2010 Compared to Three and Six Months Ended June 30, 2009

#### Sales

| Sales by Product Line (in thousands) | Three months ended June 30, 2010 | 2009 | Percent change 2010 | Six months ended June 30, 2009 |  | Percent change |
| --- | ---: | ---: | ---: | ---: | ---: | ---: |
| Electrosurgical | $3,840 | $4,704 | (18.4%) | $7,460 | $9,908 | (24.7%) |
| Cauteries | 1,592 | 1,608 | (1.0%) | 3,112 | 3,048 | 2.1% |
| Other | 465 | 520 | (10.6%) | 924 | 1,092 | (15.4%) |
| Total | $5,897 | $6,832 | (13.7%) | $11,496 | $14,048 | (18.2%) |

| Sales by Domestic and International (in thousands) | Three months ended June 30, 2010 | 2009 | Percent change 2010 | Six months ended June 30, 2009 |  | Percent change |
| --- | ---: | ---: | ---: | ---: | ---: | ---: |
| Domestic | $4,678 | $5,748 | (18.6%) | $8,971 | $11,615 | (22.8%) |
| International | 1,219 | 1,084 | 12.5% | 2,525 | 2,433 | 3.8% |
| Total | $5,897 | $6,832 | (13.7%) | $11,496 | $14,048 | (18.2%) |

Sales for the three months ended June 30 2010 decreased approximately $935,000 or 13.7% compared to the same period in 2009. This decrease was due to the following reasons:

- sales of overall electrosurgical disposables were down approximately $1.3 million or 64.6% mainly due to a reduction in the sale of ablators offset by an increase in the sale of electrodes; and
- sales of other products were down approximately $56,000 or 10.7% mainly due to a reduction in the sale of penlights.

These decreases in sales in the second quarter of 2010 from 2009 were partially offset by:

- sales of generators increased approximately $242,000 or 8.4% due to increase demand from our OEM vendors, hospitals and our distribution sales to doctor’s offices; and
- international sales of approximately $135,000 or 12.5% due to generally increased demand in the global market.

Sales for the six months ended June 30, 2010 decreased approximately $2.552 million or 18.2% compared to the same period in 2009. This decrease was due to the following reasons:

- sales of generators were down approximately $157,000 or 2.6% due to lower capital expenditures by hospitals and doctors offices in the first quarter offset by an increase in sales from our OEM vendors, hospitals and our distribution sales to doctor’s offices;
- sales of electrosurgical disposable decreased approximately $2.383 million mainly due to decreased sales of ablators offset by an increase in sales of electrodes; and
- sales of other products were down approximately $168,000 or 15.4% mainly due to a reduction in the sale of penlights.

These decreases in sales in for the period ending June 30, 2010 from the same period in 2009 were partially offset by:

- an increase in international sales of approximately $92,000 or 3.8% due to increased demand from the global markets; and
- an increase in cautery sales of approximately $64,000 or 1.0%.

#### Gross Profit

*(in thousands)*

|  | Three months ended June 30, 2010 | 2009 | Percent of sales 2010 | 2009 | Percent change 2010 | Six months ended June 30, 2009 | 2010 | Percent of sales 2009 |  | Percent change |
| --- | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: |
| Cost of sales | $3,581 | $3,850 | 60.7% | 56.4% | (7.0%) | $6,895 | $7,748 | 60.0% | 55.1% | (11.0%) |
| Gross profit | $2,316 | $2,981 | 39.3% | 43.6% | (22.3%) | $4,601 | $6,301 | 40.0% | 44.9% | (27.0%) |

Gross profit decreased approximately $665,000 or 22.3% as a percentage of sales for the three months ended June 30, 2010 in the second quarter of 2010 compared to the same period in 2009. This decrease was primarily due to the following reasons:

- gross profit decreased by approximately $408,000 due to the reduction of sales for the quarter. A large portion of this reduction was related to the decrease in sales of our electrosurgical disposable products, a higher profit margin product line, and therefore resulted in the decrease of gross margin as a percentage of sales;
- a decrease of approximately $125,000 related to a reduction in labor and material costs attributed to the consolidation of our Canadian operations to Florida in the second quarter;
- a $36,000 increase in depreciation expense;
- a $77,000 decrease in capitalized manufacturing overhead as it relates to inventory; and
- a $55,000 increase in material costs.

The decrease in gross profit in the three months ended June 30, 2010 from the same period 2009 was partially offset by a decrease in shipping costs.

Gross profit for the six months ended June 30, 2010 decreased approximately $1.7 million or 27.0%, as compared to the same period in 2009. This decrease was primarily due to the following reasons:

- gross profit decreased approximately $1.2 million due to reduced sales. A large portion of these reduced sales were related to our electrosurgical disposable products, a higher profit margin product line, and therefore resulted in the decrease of gross margin as a percentage of sales;
- a $212,000 decrease in the capitalized manufacturing overhead;
- a $72,000 increase in depreciation expense;
- a $148,000 increase in material costs; and
- a $225,000 decrease in gross profit primarily related to a reduction in labor and material costs attributed to the consolidation of our Canadian operations to Florida.

The decrease in gross profit for the six month period ending June 30, 2010 as compared to the same period in 2009 were partially offset by a $105,000 decrease in shipping costs.

#### Research and Development Expense

*(in thousands)*

|  | Three months ended June 30, 2010 | 2009 | Percent of sales 2010 | 2009 | Percent change 2010 | Six months ended June 30, 2009 | 2010 | Percent of sales 2009 |  | Percent change |
| --- | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: |
| R & D Expense | $525 | $521 | 8.9% | 7.6% | 0.8% | $1,024 | $1,001 | 8.9% | 7.1% | 2.3% |

Research and development expense increased approximately $4,000 or 0.8% in the three months ended June 30, 2010 as compared to the same period in 2009. This increase was primarily due to the following reasons:

- a $18,000 increase in engineering cost for additional staffing to support the vessel sealing product line;
- a $81,000 increase in consulting costs to support the vessel sealing product line; and
- a $35,000 increase in other research and development costs to support new products.

The increase in research and development expense for the three months ended June 30, 2010 as compared to the same period in 2009 were partially offset by a $130,000 decrease in labor and other development costs related to the consolidation of our Canadian operations to our Clearwater, Florida facility.

The 2.3% increase in research and development expense of approximately $23,000 for the six months ended June 30, 2010, as compared to the same period in 2009 was a result of the following:

- a $55,000 increase in engineering cost for additional staffing to support the vessel sealing product line;
- a $166,000 increase in consulting costs to support the vessel sealing product line; and
- a $55,000 increase in other research and development costs to support new products.

The increase in research and development expense for the six months ended June 30, 2010 as compared to the same period in 2009 was partially offset by a $253,000 decrease in labor and other development costs related to the consolidation of our Canadian operations to our Clearwater, Florida facility.

#### Professional Services

*( in thousands)*

|  | Three months ended June 30, 2010 | 2009 | Percent of sales 2010 | 2009 | Percent change 2010 | Six months ended June 30, 2009 | 2010 | Percent of sales 2009 |  | Percent change |
| --- | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: |
| Professional services | $343 | $275 | 5.8% | 4.0% | 24.4% | $678 | $720 | 5.9% | 5.1% | (5.9%) |

The 24.4% increase in professional services expense of approximately $67,000 in the three months ended June 30, 2010 as compared to the same period in 2009 was due to the following reasons:

- a $42,000 increase in consulting cost mainly due to the engagement of Growthink to support the marketing of new products;
- a $23,000 increase in accounting fees mainly due to the timing of the audit and tax work in 2010 versus 2009; and
- a $2,000 increase in consulting fees for Bovie Canada resulting from the consolidation of operations to Florida.

The 5.9% decrease in professional services expense of approximately $42,000 for the six months ended June 30, 2010 as compared to the same period in 2009 was a result of the following:

- a $11,000 decrease in professional fees for Bovie Canada due to the consolidation of operations to Florida;
- a $15,000 decrease in accounting costs mainly due to the valuation work done in the first quarter of 2009; and
- a $38,000 decrease in legal fees mainly due to hiring a new internal general counsel partially offset by an increase in legal fees for filings and other legal matters that developed in the second quarter of 2010.

These decreases in professional services expense for period ending June 30, 2010 as compared to the same period in 2009 were mainly offset by a $22,000 increase in consulting for Growthink.

#### Salaries

*( in thousands)*

|  | Three months ended June 30, 2010 | 2009 | Percent of sales 2010 | 2009 | Percent change 2010 | Six months ended June 30, 2009 | 2010 | Percent of sales 2009 |  | Percent change |
| --- | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: |
| Salaries & related cost | $857 | $771 | 14.5% | 11.3% | 11.2% | $1,604 | $1,545 | 14.0% | 11.0% | 3.9% |

The 11.2% increase in salaries and related cost of approximately $87,000 in the three months ended June 30, 2010 as compared to the same period in 2009 was due primarily to the following reasons:

- a $125,000 increase in salaries due to the hiring of new internal general counsel, which includes a onetime $80,000 salary payment to cover moving costs;
- a $16,000 increase in indirect administrative costs due to timing of vacation;
- a $5,000 increase in health insurance cost; and
- a $4,000 increase in employee benefits.

The increase in salaries and related cost for the three months ended June 30, 2010 as compared to the same period in 2009 was partially offset by:

- a $57,000 decrease in marketing salaries from the elimination of two high level marketing positions; and
- a $6,000 decrease due to a reduction of an administrative position from the consolidation of our Canadian operations to Florida.

The 3.9% increase in salaries and related cost of approximately $60,000 for the six months ending June 30, 2010 as compared to the same period in 2009 was primarily the a result of the following:

- $140,000 increase in salaries due to new legal counsel, which includes a onetime $80,000 salary payment to cover moving costs;
- a $19,000 increase in health insurance cost;
- a $13,000 increase in compensation expense due to the issuance of new options; and
- a $4,000 increase in employee benefits.

The increase in salaries and related cost for the six months ending June 30, 2010 as compared to the same period in 2009 was partially offset by a $116,000 decrease in marketing salaries resulting from the elimination of two high level marketing positions.

#### Selling, General & Administrative Expenses

*(in thousands)*

|  | Three months ended June 30, 2010 | 2009 | Percent of sales 2010 | 2009 | Percent change 2010 | Six months ended September 30, 2009 | 2010 | Percent of sales 2009 |  | Percent change |
| --- | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: |
| SG & A costs | $1,383 | $1,139 | 23.5% | 16.7% | 21.5% | $2,418 | $2,220 | 21.0% | 15.8% | 8.9% |

The 21.5% increase in selling, general and administrative costs of approximately $244,000 for the three months ended June 30, 2010 as compared to the same period in 2009 was due to the following reasons:

- a $21,000 increase in advertising costs to support our distribution and new product sales;
- a $36,000 increase in regulatory costs to support our new products;
- a $33,000 increase in promotional training for our distribution and new government contract sales;
- a $19,000 increase in consulting costs for the development of the surgical suite marketing plan;
- a $9,000 increase in royalty payments for the Meg product line;
- a $13,000 increase in trade show costs resulting from timing of trade shows versus the prior period;
- a $80,000 increase in Bovie Canada cost due to one time write-offs attributable to the consolidation of operations to Florida;
- a $39,000 increase in travel costs as a result travel to support the development and sale of new products;
- a $26,000 increase in commission expense due to increased distribution sales;
- a $23,000 increase in foreign currency loss due to fluctuation in rates attributable to vendor payments and the consolidation of our Canadian operations to Florida; and
- a $4,000 increase in credit card and bank fees as more customers are paying by credit card.

The increase in selling, general and administrative costs for the three months ended June 30, 2010 as compared to the same period in 2009 were partially offset by:

- a $22,000 decrease in phone costs as a result of the move to the new building in the second quarter of 2009;
- a $20,000 decrease in depreciation expense attributable to the consolidation of our Canadian operations to Florida; and
- a $17,000 reduction in moving costs due to the move to our new facility in Clearwater, Florida in 2009 costing more than the move to consolidate our Canadian operations to Florida.

The 8.9% increase in selling, general and administrative costs of approximately $198,000 for the six months ending June 30, 2010 as compared to the same period in 2009 was a result of the following:

- $76,000 increase in Bovie Canada cost due to one time write-offs attributable to the consolidation of operations to Florida;
- a $25,000 increase in consulting costs for the development of the surgical suite marketing plan;
- a $20,000 increase in advertising costs and marketing supplies to support our distribution and new product sales;
- a $47,000 increase in regulatory costs to support our new products;
- a $30,000 increase in travel costs as a result travel to support the development and sale of new products;
- a $18,000 increase in show costs resulting from timing of shows versus the prior period;
- a $14,000 loss on disposition of fixed assets related to our move to the new facility;
- a $36,000 increase in foreign currency loss due to fluctuation in rates attributable to vendor payments and the consolidation of our Canadian operations to Florida;
- a $22,000 increase in credit card and bank fees as more customers are paying by credit card;
- a $16,000 increase in taxes and license costs related to our moving to the new facility;
- a $16,000 increase in promotional training for our distribution and new government contract sales;
- a $15,000 increase in royalty payments for the Meg product line;
- a $21,000 increase in repair and maintenance due to supporting a larger facility; and
- a 16,000 increase in computer and infrastructure costs to support our new products.

These increases in selling, general and administrative cost for the six months ending June 30, 2010 as compared to the same period in 2009 were offset by:

- a $31,000 decrease in general insurance expense due to an increase in insurance costs offset by a credit from an insurance audit;
- moving cost related to moving our Canadian facility in 2010 were lower by $17,000 as compared to the moving costs in 2009 related to our moving our St. Petersburg facility to our new Clearwater facility in Florida;
- a $45,000 decrease in consulting costs related to our European sales distribution channel;
- a $19,000 decrease in depreciation expense attributable to the consolidation of our Canadian operations to Florida;
- a $24,000 decrease in utility expense attributable to finalizing the consolidation of our operations in Florida; and
- a $38,000 decrease in phone costs as a result of the move to the new building in the second quarter of 2009.

#### Other Income

*(in thousands)*

|  | Three months ended June 30, 2010 | 2009 | Percent of sales 2010 | 2009 | Percent change 2010 | Six months ended June 30, 2009 | 2010 | Percent of sales 2009 |  | Percent change |
| --- | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: |
| Interest income (expense) | $(67) | $(11) | (1.1%) | (0.2%) | (501%) | $(111) | $56 | (1.1%) | 0.4% | (297%) |
| Change in fair value of liabilities | $617 | $- | 10.5% | - | - | $617 | $- | 5.4% | - |  |

Net interest expense increased by approximately $56,000 or 501% in the three months ended June 30, 2010 as compared to the same period in 2009 as a significant amount of our interest was capitalized during the three months ended June 30, 2009.

For the six-month period ended June 30, 2010 as compared to the same period in 2009, net interest income increased by $167,000, as a significant amount of our interest was capitalized during the six months ended June 30, 2009.

During the quarter ended June 30, 2010 we recorded a gain in the amount of approximately $555,000 for the change in fair value of the warrant liability related to our recent private placement equity issuance in April of 2010. We are required to revalue these warrants at the end of each reporting period and reflect in the consolidated statement of operations a gain or loss for the change in fair value of the warrant liability in the period in which the change occurred. We calculate the fair value of the warrants outstanding using a binomial lattice model (see Note 7). A gain results principally from a decline in our share price during the period and a loss results principally from an increase in our share price. On April 18, 2010, the date of issuance, the derivative warrant liability had a value of approximately $779,000 and at June 30, 2010 was valued at approximately $244,000.

#### Income Taxes

For the six months ended June 30, 2010 and 2009, we recorded a net benefit for income tax and provisions for income taxes of $447,000 and $265,000, respectively. The effective tax rates for the six months ended June 30, 2010 and 2009 were zero and 30.4%, respectively.

### Product Development

We have developed most of our products and product improvements internally. Funds for this development have come primarily from our internal cash flow and from the proceeds of our recently completed private placement. We maintain close working relationships with physicians and medical personnel in hospitals and universities who assist in product research and development. New and improved products play a critical role in our sales growth. We continue to emphasize the development of proprietary products and product improvements to complement and expand our existing product lines. We have a centralized research and development focus, with our Clearwater, Florida location responsible for new product development and product improvements. Our research, development and engineering units at the manufacturing locations maintain relationships with distribution locations and customers to provide an understanding of changes in the market and product needs. During 2010, we continued to invest in ICON GS (J-Plasma technology), ICON VS, vessel sealing technology, Aaron 1450, and BOSS. We intend to pay the ongoing costs for this development from operating cash flows.

In the next year, we do not contemplate any material purchase or acquisition of assets that our ordinary cash flow and/or credit line would be unable to sustain.

### Reliance on Collaborative, Manufacturing and Selling Arrangements

We depend on certain contractual OEM customers for product development. In these situations, we plan to manufacture the products developed. The customer has no legal obligation, however, to purchase the developed products. If the collaborative customer fails to give us purchase orders for the product after development, our future business and value of related assets could be negatively affected. Furthermore, we can give no assurance that a collaborative customer may give sufficient high priority to our products. In addition, disagreements or disputes may arise between us and our contractual customers, which could adversely affect production of our products. We also have informal collaborative arrangements with two foreign suppliers in which we request the development of certain items and components, and we purchase them pursuant to purchase orders. Our purchase orders are never longer than one year and are supported by orders from our customers.

### Liquidity and Capital Resources

Our working capital at June 30, 2010 increased by approximately $2.0 million to $12.7 million from approximately $10.7 million at December 31, 2009. This increase was mainly attributed to the cash received from the April 18, 2010 private equity issuance. Accounts receivable days sales outstanding were 43.6 days and 34.1 days at June 30, 2010 and 2009 respectively. The number of days worth of sales in inventory, which is the total inventory available for production divided by the 12 month average cost of materials, increased 100 days to 272 days equating to an inventory turn ratio of 1.3 at June 30, 2010 from 172 days and an inventory turn ratio of 1.7 at December 31, 2009. The higher number of days worth of sales in inventory which translated into a lower inventory turnover rate is mainly due to the decrease in sales related to our generator product lines which contain a greater number of parts compared to all our other products.

We used cash from operations of approximately $370,000 for the six months ended June 30, 2010, compared to generating approximately $390,000 for the same period of 2009, a decrease of approximately $760,000.

In the six month period ended June 30, 2010 we used approximately $287,000 for the purchase of property and equipment as compared to purchases amounting to approximately $2.1 million for the same period in 2009. The decrease relates to the difference between the amounts expended to refurbish our new Clearwater, Florida facility in the first half of 2009.

We generated cash from financing activities of approximately $1.8 million during the first six months of 2010, a decrease of approximately $400,000 compared with the same period in 2009. The net decrease in cash from financing activities resulted from the following:

- a decline in proceeds from the escrow account of approximately $36,000;
- an increase in cash resulting from sales of our common shares of approximately $2.8 million net of placement costs; and
- a net change in the line of credit of approximately $1 million.

During fiscal 2008, we borrowed $4.0 million through the issuance of industrial revenue bonds for the purchase and renovation of our new facility through RBC Bank, of which we received $2.7 million in 2008 and the remaining escrow portion of approximately $1.3 million in 2009. The bonds, which are being amortized over a 20 year term, balloon in 10 years and bear interest at a fixed interest rate of 4.6%. Scheduled maturities of this indebtedness are $135,000, $140,000, $145,000, $155,000 and $165,000 for 2010, 2011, 2012, 2013 and 2014 respectively.

We had approximately $3.4 million in cash and cash equivalents at June 30, 2010. We believe our cash on hand, as well as anticipated cash flows from operations, will be sufficient to meet our operating cash commitments for the next year. Should additional funds be required, we have secured additional borrowing capacity with RBC Bank (USA). (see below)

On December 2, 2009 RBC Bank (USA) increased our secured revolving line of credit facility to $8 million from the previous $5 million and on the same date provided us with a separate additional credit facility for up to $1 million specific to financing new equipment purchases.

Advances under the $8 million line of credit are due on demand and bear interest at a rate of LIBOR plus 2% with a minimum floor rate of 4.0% and are secured by a perfected first security interest in our inventory, and accounts receivable.

The $1 million facility related to equipment purchases provides for a 2 year draw up period followed by a 5 year term period and bears interest also at LIBOR plus 2% with a minimum floor of 4% and will be secured by a perfected first security interest in the new equipment purchased. This equipment credit facility also allows us the option of financing purchased equipment at 75% of the cost through either a traditional loan or through RBC leasing at the time of purchase.

Subsequent available borrowings for both these credit facilities is subject to a borrowing base utilizing a percentage of eligible receivables, inventories, and any assigned cash along with certain financial ratios, specifically maintaining: a ratio of debt to tangible net worth of less than 2.0 to 1.0, a ratio of total funded debt to EBITDA of less than 3.25 to 1.0 excluding the industrial revenue bond note balance which had an original principal amount of $4.0 million, and a ratio of minimum debt service coverage of 1.5 to 1.0 measured on a rolling four quarter basis.

At June 30, 2010 we were in full compliance with the loan covenants and ratios of both the credit facilities. According to our most recent borrowing base calculation we had approximately $4.0 million total availability under the $8 million credit line, of which we currently have a zero balance. We also have available all of the $1 million under the equipment line of credit.

On April 18, 2010, we entered into a Securities Purchase Agreement with certain investors who purchased common stock and warrants in a private placement pursuant to Section 4(2) of the Securities Act of 1933, as amended, and/or Regulation D promulgated. This offering, which closed on April 28, 2010, resulted in gross proceeds of approximately $2.8 million. (See Note 7)

Our future contractual obligations for agreements with initial terms greater than one year and agreements to purchase materials in the normal course of business are summarized as follows (in thousands):

| Description | Years Ending December 31, 2010 | 2011 | 2012 | 2013 | 2014 | 2015 |
| --- | ---: | ---: | ---: | ---: | ---: | ---: |
| Operating leases | $139 | $252 | $247 | $223 | $11 | $- |
| Employment agreements | $405 | $865 | $871 | $881 | $73 | $- |
| Purchase Commitments | $3,250 | $- | $- | $- | $- | $- |

23

### Critical Accounting Estimates

In preparing the consolidated financial statements in accordance with accounting principles generally accepted in the United States of America (U.S. GAAP), we have adopted various accounting policies. Our most significant accounting policies are disclosed in Note 2 to the consolidated financial statements included in our Form 10K filed in March 2010.

The preparation of the consolidated financial statements in conformity with U.S. GAAP requires us to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Our estimates and assumptions, including those related to inventories, intangible assets, property, plant and equipment, legal proceedings, research and development, warranty obligations, product liability, sales returns and discounts, and income taxes are updated as appropriate, which in most cases is at least quarterly. We base our estimates on historical experience, or various assumptions that are believed to be reasonable under the circumstances and the results form the basis for making judgments about the reported values of assets, liabilities, revenues and expenses. Actual results may materially differ from these estimates.

Estimates are considered to be critical if they meet both of the following criteria: (1) the estimate requires assumptions about material matters that are uncertain at the time the accounting estimates are made, and (2) other materially different estimates could have been reasonably made or material changes in the estimates are reasonably likely to occur from period to period. Our critical accounting estimates include the following:

### Inventory reserves

When necessary we maintain reserves for excess and obsolete inventory resulting from the potential inability to sell our products at prices in excess of current carrying costs. The markets in which we operate are highly competitive, with new products and surgical procedures introduced on an ongoing basis. Such marketplace changes may cause our products to become obsolete. We make estimates regarding the future recoverability of the costs of these products and record a provision for excess and obsolete inventories based on historical experience, and expected future trends. If actual product life cycles, product demand or acceptance of new product introductions are less favorable than projected by management, additional inventory write-downs may be required, which would unfavorably affect future operating results.

### Long-lived assets

We review long-lived assets which are held and used, including property and equipment and intangible assets, for impairment whenever changes in circumstances indicate that the carrying amount of the assets may not be recoverable. Such evaluations compare the carrying amount of an asset to future undiscounted net cash flows expected to be generated by the asset over its expected useful life and are significantly impacted by estimates of future prices and volumes for our products, capital needs, economic trends and other factors that are inherently difficult to forecast. If the asset is considered to be impaired, we record an impairment charge equal to the amount by which the carrying value of the asset exceeds its fair value determined by either a quoted market price, if any, or a value determined by utilizing a discounted cash flow technique.

### Liabilities valued at fair value

We generally do not use derivative financial instruments to hedge exposures to cash-flow risks or market-risks. However, certain financial instruments, such as warrants, which are indexed to our common stock, are classified as liabilities when either (a) the holder possesses rights to net-cash settlement or (b) physical or net-share settlement is not within our control. In such instances, net-cash settlement is assumed for financial accounting and reporting purposes, even when the terms of the underlying contracts do not provide for net-cash settlement. Such financial instruments are initially recorded, and continuously carried, at fair value.

Determining the fair value of these instruments involves judgment and the use of certain relevant assumptions including, but not limited to, interest rate risk, historical volatility and stock price, estimated life of the derivative, antidilution provisions, and conversion/redemption privileges. The use of different assumptions or changes in those assumptions could have a material effect on the estimated fair value amounts.

### Share-based Compensation

Under the Company’s stock option plan, options to purchase Common Shares of the Company may be granted to key employees, officers and directors of the Company by the Board of Directors. The Company accounts for stock options in accordance with FASB ASC Topic 718, *Compensation-Stock Compensation* with option expense amortized over the vesting period based on the binomial lattice option-pricing model fair value on the grant date, which includes a number of estimates that affect the amount of our expense.

### Income Taxes

The provision for income taxes includes federal, foreign, state and local income taxes currently payable and those deferred because of temporary differences between the financial statement and tax bases of assets and liabilities. Deferred tax assets or liabilities are computed based on the difference between the financial statement and income tax bases of assets and liabilities using enacted marginal tax rates. Valuation allowances are recorded to reduce deferred tax assets when it is more likely than not that a tax benefit will not be realized. Deferred income tax expenses or credits are based on the changes in the asset or liability from period to period.

We periodically have net operating loss and tax credit carry forwards available to reduce future taxable income. Future tax benefits for net operating loss and tax credit carry forwards are recognized to the extent that realization of these benefits is considered more likely than not. This determination is based on the expectation that related operations will be sufficiently profitable or various tax, business and other planning strategies will enable us to utilize the operating loss and tax credit carry forwards. We cannot be assured that we will be able to realize these future tax benefits or that future valuation allowances will not be required. To the extent that available evidence raises doubt about the realization of a deferred income tax asset, a valuation allowance is established.

It is our policy to provide for uncertain tax positions and the related interest and penalties based upon management’s assessment of whether a tax benefit is more likely than not to be sustained upon examination by tax authorities. To the extent that the probable tax outcome of these uncertain tax positions changes, such changes in estimate will impact the income tax provision in the period in which such determination is made. At June 30, 2010, we were currently under examination by the Internal Revenue Service for our 2008 tax year. We believe we have appropriately accounted for any unrecognized tax benefits. To the extent we prevail in matters for which a liability for an unrecognized tax benefit is established or we are required to pay amounts in excess of the liability, our effective tax rate in a given financial statement period may be affected.

## Market risk

As filed, 702 characters.

Our short term investments consist of cash, cash equivalents and overnight investments. As such we do not believe we are exposed to significant interest rate risk. The primary objective of our investment activities is to preserve principal while at the same time maximizing yields without significantly increasing risk. To achieve this objective, we invest in highly liquid overnight money market investments. If a 10% change in interest rates were to have occurred on June 30, 2010, this change would not have had a material effect on the fair value of our investment portfolio as of that date. Similarly, such an increase in rates on our borrowings would not have a material impact on our operations.

## Controls and procedures

As filed, 1,755 characters.

### Evaluation of Disclosure Controls and Procedures

We have carried out an evaluation, under the supervision of and with the participation of our management, including our Chief Executive Officer (CEO) and Chief Financial Officer (CFO), of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended), as of June 30, 2010. Based upon that evaluation, our CEO and CFO concluded that, as of June 30, 2010, our disclosure controls and procedures are effective in providing reasonable assurance that (a) the information required to be disclosed by us in the reports that we file or submit under the Securities Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and (b) such information is accumulated and communicated to our management, including our CEO and CFO, as appropriate to allow timely decisions regarding required disclosure. In designing and evaluating our disclosure controls and procedures, our management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and our management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

### Changes in Internal Controls

There were no changes in our internal control over financial reporting (as defined in Rules 13(a)-15(f) and 15(d)-15(f)) during the three months ended June 30, 2010 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

## Risk factors

As filed, 141 characters.

There have been no material changes to the Risk Factors previously disclosed in our report on Form 10-K for the year ended December 31, 2009.

Filed Aug 9, 2010.
Source: SEC EDGAR, the filing index for accession 0001140361-10-032168. Last ingested by Listed: Nov 5, 2026, 13:09 ET. No prices; not investment advice.