# Apyx Medical Corp: Form 10-Q for the period ended Sep 30, 2012

- Company: [Apyx Medical Corp](/companies/apyx.md) (CIK 719135)
- Form: 10-Q
- Filed: 2012-11-14
- Accepted by EDGAR: Nov 14, 2012, 06:27 ET
- Period: 2012-09-30
- Accession: 0001140361-12-046982
- Inline XBRL: yes
- Main document: https://www.sec.gov/Archives/edgar/data/719135/000114036112046982/form10q.htm
- All documents and exhibits: https://www.sec.gov/Archives/edgar/data/719135/000114036112046982/

## Figures reported in this filing

Standardized XBRL line items for the period ended 2012-09-30.

| Line item | Period | Value | XBRL concept |
| --- | --- | ---: | --- |
| Revenue | 3 months, 2012-07-01 to 2012-09-30 | $6.7m | us-gaap:SalesRevenueNet |
| Revenue | 9 months, 2012-01-01 to 2012-09-30 | $20.8m | us-gaap:SalesRevenueNet |
| Cost of revenue | 3 months, 2012-07-01 to 2012-09-30 | $3.8m | us-gaap:CostOfGoodsAndServicesSold |
| Cost of revenue | 9 months, 2012-01-01 to 2012-09-30 | $12.3m | us-gaap:CostOfGoodsAndServicesSold |
| Gross profit | 3 months, 2012-07-01 to 2012-09-30 | $2.9m | us-gaap:GrossProfit |
| Gross profit | 9 months, 2012-01-01 to 2012-09-30 | $8.5m | us-gaap:GrossProfit |
| Research and development | 3 months, 2012-07-01 to 2012-09-30 | $322.0k | us-gaap:ResearchAndDevelopmentExpense |
| Research and development | 9 months, 2012-01-01 to 2012-09-30 | $969.0k | us-gaap:ResearchAndDevelopmentExpense |
| Selling, general and administrative | 3 months, 2012-07-01 to 2012-09-30 | $1.1m | us-gaap:SellingGeneralAndAdministrativeExpense |
| Selling, general and administrative | 9 months, 2012-01-01 to 2012-09-30 | $3.2m | us-gaap:SellingGeneralAndAdministrativeExpense |
| Operating income | 3 months, 2012-07-01 to 2012-09-30 | $282.0k | us-gaap:OperatingIncomeLoss |
| Operating income | 9 months, 2012-01-01 to 2012-09-30 | $918.0k | us-gaap:OperatingIncomeLoss |
| Income tax | 3 months, 2012-07-01 to 2012-09-30 | $96.0k | us-gaap:IncomeTaxExpenseBenefit |
| Income tax | 9 months, 2012-01-01 to 2012-09-30 | $304.0k | us-gaap:IncomeTaxExpenseBenefit |
| Net income | 3 months, 2012-07-01 to 2012-09-30 | −$7.0k | us-gaap:NetIncomeLoss |
| Net income | 9 months, 2012-01-01 to 2012-09-30 | $331.0k | us-gaap:NetIncomeLoss |
| Diluted EPS | 3 months, 2012-07-01 to 2012-09-30 | $0.00 | us-gaap:EarningsPerShareDiluted |
| Diluted EPS | 9 months, 2012-01-01 to 2012-09-30 | $0.02 | us-gaap:EarningsPerShareDiluted |
| Basic EPS | 3 months, 2012-07-01 to 2012-09-30 | $0.00 | us-gaap:EarningsPerShareBasic |
| Basic EPS | 9 months, 2012-01-01 to 2012-09-30 | $0.02 | us-gaap:EarningsPerShareBasic |
| Diluted shares (weighted) | 3 months, 2012-07-01 to 2012-09-30 | 17,634,000 shares | us-gaap:WeightedAverageNumberOfDilutedSharesOutstanding |
| Diluted shares (weighted) | 9 months, 2012-01-01 to 2012-09-30 | 17,731,000 shares | us-gaap:WeightedAverageNumberOfDilutedSharesOutstanding |
| Operating cash flow | 9 months, 2012-01-01 to 2012-09-30 | $154.0k | us-gaap:NetCashProvidedByUsedInOperatingActivities |
| Capital expenditure | 9 months, 2012-01-01 to 2012-09-30 | $449.0k | us-gaap:PaymentsToAcquirePropertyPlantAndEquipment |
| Cash and equivalents | at 2012-09-30 | $4.5m | us-gaap:CashAndCashEquivalentsAtCarryingValue |
| Current assets | at 2012-09-30 | $16.3m | us-gaap:AssetsCurrent |
| Total assets | at 2012-09-30 | $28.0m | us-gaap:Assets |
| Current liabilities | at 2012-09-30 | $1.9m | us-gaap:LiabilitiesCurrent |
| Total liabilities | at 2012-09-30 | $5.5m | us-gaap:Liabilities |
| Shareholders' equity | at 2012-09-30 | $22.6m | us-gaap:StockholdersEquity |

## Management's discussion and analysis

As filed, 36,672 characters.

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

This report contains statements that we believe to be “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange act of 1934, as amended. 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, 2011, 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:
- 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.

#### Executive Level 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, Medical Illumination (MII) Lighting, laparoscopic instruments, license fees, development fees and other miscellaneous income.

Most of our products currently 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 approximately 18.8% of total revenues for the first nine months of 2012, as compared with approximately 22.7% for the first nine months of 2011. Our products are sold in more than 150 countries mainly through local dealers which are coordinated by sales and marketing personnel at the Clearwater, Florida facility. In addition, for the launch of our new surgical suite / J-Plasma product lines, we have established the use of a network of approximately 50 commission-based independent direct sales contractors to market these products. Our business is generally not seasonal in nature.

### Results of Operations – Three and Nine Months Ended September 30, 2012 Compared to Three and Nine Months Ended September 30, 2011

#### Sales

| Sales by Product Line (in thousands) | Three months ended September 30, 2012 | 2011 | Percent change 2012 | Nine months ended September 30, 2011 |  | Percent change |
| --- | ---: | ---: | ---: | ---: | ---: | ---: |
| Electrosurgical | $4,149 | $3,989 | 4.0% | $13,417 | $12,905 | 4.0% |
| Cauteries | 1,878 | 1,577 | 19.1% | 5,181 | 4,720 | 9.8% |
| Other | 644 | 690 | (6.7)% | 2,245 | 1,627 | 38.0% |
| Total | $6,671 | $6,256 | 6.6% | $20,843 | $19,252 | 8.3% |

17

#### Index

| Sales by Domestic and International (in thousands) | Three months ended September 30, 2012 | 2011 | Percent change 2012 | Nine months ended September 30, 2011 |  | Percent change |
| --- | ---: | ---: | ---: | ---: | ---: | ---: |
| Domestic | $5,308 | $5,024 | 5.7% | $16,865 | $14,835 | 13.7% |
| International | 1,363 | 1,232 | 10.6% | 3,978 | 4,417 | (9.9)% |
| Total | $6,671 | $6,256 | 6.6% | $20,843 | $19,252 | 8.3% |

During the three months ended September 30, 2012, we experienced increases in demand in both of our primary product line categories. The largest dollar sales increases occurred in our cauteries category amounting to approximately $301,000, or a 19.1% increase for the three months ended September 30, 2012 compared to the same period in 2011. The 4.0% sales increase experienced in our electrosurgical category during the three months ended September 30, 2012 compared to the same period in 2011, was mainly attributable to increased demand for our electrosurgical generators both internationally and with our domestic OEM customer amounting to approximately $160,000. We experienced a 6.7% decrease, or approximately $46,000, in our “other products” category sales for the three months ended September 30, 2012 when compared to the same period in 2011.

Sales during the nine months ended September 30, 2012 increased approximately $1.6 million or 8.3% compared to the same period in 2011. Our largest dollar sales increase which approximated $618,000 or 38% was in our “other products” category. This increase was also related to the sales trend of our new medical lighting systems and laproscopic instruments, amounting to increases of approximately $523,000 and $48,000 respectively. Some additional contributing factors to these increases were in various other products as well as engineering consulting services for which the combined net increase approximated $47,000 for the nine months ended September 30, 2012 as compared to the same period in 2011. The stronger demand for our OEM domestic electrosurgical generators we saw at the beginning of the year continued through the nine months ended September 30, 2012 and resulted in a 4.0% sales increase in our electrosurgical category, or approximately $513,000 when compared to the same period in 2011. Our trend of increased demand from our domestic customers for cauteries continued through the nine months ended September 30, 2012 amounting to approximately $461,000 or 9.8% when compared to the same period in 2011.

Our ten largest customers accounted for approximately 66% of net revenues for the nine months ended September 30, 2012 and 67% for the same period in 2011. At September 30, 2012 and 2011, our ten largest trade receivables accounted for approximately 62% and 67% of our net receivables, respectively. During the first nine months of 2012, two of our customers each accounted for 11% of total sales. No customer accounted for greater than 10% of our sales for the same period ending September 30, 2011.

#### Gross Profit

*(in thousands)*

|  | Three months ended September 30, 2012 | 2011 | Percent of sales 2012 | 2011 | Percent change | Nine months ended September 30, 2012 | 2011 | Percent of sales 2012 | 2011 | Percent change |
| --- | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: |
| Cost of sales | $3,777 | $3,650 | 56.6% | 58.3% | 3.5% | $12,297 | $11,167 | 59.0% | 58.0% | 10.1% |
| Gross profit | $2,894 | $2,606 | 43.4% | 41.7% | 11.1% | $8,546 | $8,085 | 41.0% | 42.0% | 5.7% |

In addition to our increased overall sales, our gross profit also increased as a percentage of sales by approximately 1.7% or $288,000 for the three months ended September 30, 2012 as compared to the same period in 2011. This increase is mainly attributable to higher sales of higher profit margin products which are offset by increased costs of goods sold expenses in areas of direct labor, health insurance, and direct and indirect J-Plasma product line costs, all totaling approximately $127,000 during the three months ended September 30, 2012 as compared to the same period in 2011.

Our gross profit for the nine months ended September 30, 2012 increased by approximately $461,000, or 5.7%, as compared to the same period in 2011. Although our gross profit was an increase in actual dollars it amounted to a 1% decrease as a percentage of sales, which was primarily attributable to higher sales of lower profit margin OEM generators during the period, lower sales of our higher profit margin generators sold through distribution during the period, a 70% cost of sales attributable to the additional medical lighting systems sales which we only began selling in the third quarter of 2011, and increases related to direct and indirect costs in the initial manufacture and roll out of our J-Plasma product line.

#### Other Gain

### Salient/Medtronic Settlement

During the nine months ended September 30, 2011, we entered into a settlement agreement related to the legal action with Salient Surgical Technologies, Inc. and Medtronic, Inc. The settlement called for us and related parties to immediately exit and not enter into the monopolar and bipolar saline-enhanced RF device business (including SEER TM) worldwide through February 2015. In exchange, Salient made a one-time payment to us of $750,000.

#### Research and Development Expense

*(in thousands)*

|  | Three months ended September 30, 2012 | 2011 | Percent of sales 2012 | 2011 | Percent change | Nine months ended September 30, 2012 | 2011 | Percent of sales 2012 | 2011 | Percent change |
| --- | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: |
| R & D Expense | $322 | $288 | 4.8% | 4.6% | 11.8% | $969 | $924 | 4.6% | 4.8% | 4.9% |

We experienced an increase in research and development costs approximating $34,000 or 11.8% in the three months ended September 30, 2012 as compared to the same period in 2011, which were directly related to increased engineering labor, consulting, and testing costs related to advancing the J-Plasma product line as well as other new products.

During the nine months ended September 30, 2012, we experienced a 4.9% increase in research and development costs, or approximately $45,000, when compared to the same period in 2011. This increase, similar to our experience in the recent quarter, was mainly related to increased engineering labor, consulting, and testing costs with our other new products as well as advancing the J-Plasma product line.

#### Professional Services

*(in thousands)*

|  | Three months ended September 30, 2012 | 2011 | Percent of sales 2012 | 2011 | Percent change 2012 | Nine months ended September 30, 2011 | 2012 | Percent of sales 2011 |  | Percent change |
| --- | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: |
| Professional services | $408 | $289 | 6.1% | 4.6% | 41.2% | $1,061 | $906 | 5.1% | 4.7% | 17.1% |

We experienced an increase of approximately $119,000, or 41.2% in our professional services costs during the three months ended September 30, 2012 when compared to the same period in 2011. The main area of increase was in legal fees where we experienced an approximate increase of $133,000 primarily attributable to litigation expenses. This increase was offset by a reduction in accounting and auditing costs of approximately $14,000.

Our professional services costs for the nine months ended September 30, 2012 increased by approximately $155,000, or 17.1%, mainly due to increased legal fees related to existing lawsuits when compared to the same nine month period in 2011.

#### Salaries

*( in thousands)*

|  | Three months ended September 30, 2012 | 2011 | Percent of sales 2012 | 2011 | Percent change 2012 | Nine months ended September 30, 2011 | 2012 | Percent of sales 2011 |  | Percent change |
| --- | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: |
| Salaries & related cost | $781 | $785 | 11.7% | 12.5% | (0.5)% | $2,352 | $2,391 | 11.3% | 12.4% | (1.6)% |

During the three months ended September 30, 2012, we had two additional sales positions which were offset by a reduction in in-house legal salaries, as compared to the same period in 2011, which resulted in our salaries expense in dollars remaining relatively the same.

We experienced a net 1.6% decrease in salaries and related costs, or approximately $39,000, during the nine months ending September 30, 2012 as compared to the same period in 2011 for similar reasons previously mentioned and experienced during the quarter.

#### Selling, General & Administrative Expenses

*(in thousands)*

|  | Three months ended September 30, 2012 | 2011 | Percent of sales 2012 | 2011 | Percent change 2012 | Nine months ended September 30, 2011 | 2012 | Percent of sales 2011 |  | Percent change |
| --- | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: |
| SG & A costs | $1,101 | $996 | 16.5% | 15.9% | 10.5% | $3,246 | $3,231 | 15.6% | 16.8% | 0.5% |

Our selling, general and administrative costs increased by approximately $105,000, or 10.5% for the three months ended September 30, 2012 as compared to the same period in 2011. This overall increase was the net result of the following approximate offsetting amounts:

- a $61,000 decrease in bank fees and other various overhead related costs along with a gain on disposition of assets;
- increases in rental fees, shareholder and stock exchange related costs, obsolete inventory provisions, general insurance, and various other overhead related costs amounting to approximately $144,000;
- a $14,000 decrease in regulatory costs related to the support of our distribution and new product sales;
- a $21,000 decrease in amortization costs related to the Meg product line which was written-off last year;
- a $15,000 net increase in selling and marketing costs which includes trade shows, sales travel both international and domestic, and advertising; and
- a $42,000 increase in commission expense due to increased distribution sales;

For the nine months ending September 30, 2012, we experienced an increase of approximately $15,000, or 0.5% in selling, general and administrative costs as compared to the same period in 2011. This slight overall increase was the net result of the following approximate offsetting amounts:

- a $152,000 decrease in bank fees, general insurance from a premium reduction, royalty expense, obsolete inventory provisions, building maintenance utilities, and other various overhead related costs along with a gain on disposition of assets;
- a $65,000 decrease in regulatory costs related to the support of our distribution and new product sales;
- a $37,000 decrease in amortization costs related to the Meg product line which was written-off last year;
- a $56,000 decrease in miscellaneous cost related to the 2011 one time legal settlement which was absent for the same period 2012;
- increases in computers and software, rental fees, general insurance, shareholder and stock exchange related costs, and various other overhead related costs amounting to approximately $101,000;
- a $159,000 increase in selling and marketing costs related to our existing products along with our new J-Plasma line of products, which includes trade shows, sales travel both international and domestic, and advertising; and
- a $66,000 increase in commission expense due to increased distribution sales;

#### Other Income

*(in thousands)*

|  | Three months ended September 30, 2012 | 2011 | Percent of sales 2012 | 2011 | Percent change | Nine months ended September 30, 2012 | 2011 | Percent of sales 2012 | 2011 | Percent change |
| --- | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: |
| Net interest expense | $(58) | $(42) | (0.9)% | (0.7)% | 38.1% | $(175) | $(141) | (0.8)% | (0.7)% | 24.1% |
| Change in fair value of liabilities | $(135) | $(67) | (2.0)% | (1.1)% | 101.5% | $(108) | $181 | (0.5)% | 0.9% | 159.7% |

Net interest expense increased by approximately $16,000 or 38.1% in the three months ended September 30, 2012 as compared to the same period in 2011. The increase was mainly due to slightly higher interest rates and amortization of charges due to refinancing of the industrial revenue bonds in late 2011.

For the nine-month period ended September 30, 2012 as compared to the same period in 2011, net interest expense increased by $34,000. The increase was mainly due to slightly higher interest rates and amortization of charges due to refinancing of the industrial revenue bonds in late 2011.

The change in fair value of liabilities was related to the warrants associated with our equity issuance in April 2010. The derivative warrant liability was valued at approximately $105,000 at December 31, 2011 and was valued at approximately $213,000 on September 30, 2012 resulting in a year-to-date loss of approximately $108,000.

#### Income Taxes

*(in thousands)*

|  | Three months ended September 30, 2012 | 2011 | Percent of sales 2012 | 2011 | Percent change | Nine months ended September 30, 2012 | 2011 | Percent of sales 2012 | 2011 | Percent change |
| --- | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: |
| Income before income taxes | $89 | $139 | 1.3% | 2.2% | (36.0)% | $635 | $1,423 | 3.0% | 7.4% | (55.4)% |
| Provision for income taxes, net | $(96) | $(76) | (1.4)% | (1.2)% | 26.3% | $(304) | $(439) | (1.5)% | (2.3)% | 30.8% |
| Effective tax rate | 107.9% | 54.7% |  |  |  | 47.9% | 30.9% |  |  |  |

While we are subject to U.S. federal income tax as well as income tax of certain state jurisdictions, during the nine months ended September 30, 2012, our current provision was zero because the net effect of our permanent and temporary differences resulted in us recognizing a loss for tax purposes. However, for the three month period ended September 30, 2012, permanent differences related to fair value adjustments resulted in us recognizing a gain for tax purposes and our current provision was approximately $96,000. At September 30, 2012, we have remaining net operating loss carryforwards and other net deferred income tax assets of approximately $2.9 million to reduce future taxable income. Our effective tax rate of 47.9% for the nine months ended September 30, 2012 was greater than the statuatory tax rates primarily because we recognized certain losses from the fair value adjustments for financial statement purposes that are not expected to reverse (i.e. permanent differences).

#### Net Income

*(in thousands)*

|  | Three months ended September 30, 2012 | 2011 | Percent of sales 2012 | 2011 | Percent change 2012 | Nine months ended September 30, 2011 | 2012 | Percent of sales 2011 |  | Percent change |
| --- | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: |
| Net income (loss) | $(7) | $63 | (0.1)% | 1.0% | (111.1)% | $331 | $984 | 1.6% | 5.1% | (66.4)% |

21

### 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 equity issuances. 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 in Florida 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 2012, we continued to invest in expanding our J-Plasma product line and technology, ICON VS™ and the accompanying vessel sealing technology, and Aaron™ 1450. We intend to pay the ongoing costs for this development from operating cash flows.

At this time, we do not contemplate any material purchase or acquisition of assets during the next twelve months 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 two collaborative arrangements with foreign suppliers, one informal and one contractual, 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. We recently amended the manufacturing agreement with our Bulgarian supplier, which as of March 1, 2012, may result in certain contingent liabilities on our part if we terminate our arrangement prior to July 1, 2014 (see Note 10).

### Liquidity and Capital Resources

Our working capital at September 30, 2012 increased by approximately $0.3 million to $14.4 million compared to approximately $14.1 million at December 31, 2011. This increase was mainly the result of a decrease in inventory purchases and increased sales. Accounts receivable days of sales outstanding were 39.1 days and 34.8 days at September 30, 2012 and 2011, 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, decreased 13 days to 224 days equating to an inventory turn ratio of 1.5 at September 30, 2012 from 237 days and an inventory turn ratio of 1.3 at December 31, 2011. The lower number of days worth of sales is mainly due to the increased conversion of raw materials to accommodate the nine month period increased sales.

We generated cash from operations of approximately $0.2 million for the nine months ended September 30, 2012, compared to cash generated from operations of approximately $2.1 million for the same period in 2011, which included a one time gain of $750,000 resulting from a legal settlement, a decrease of approximately $1.9 million.

During the nine month period ended September 30, 2012, we used approximately $450,000 for the purchase of property and equipment as compared to purchases amounting to approximately $459,000 for the same period in 2011.

We used cash from financing activities of approximately $97,000 during the first nine months of 2012, a decrease of approximately $8,000 as compared with the same period in 2011. The decrease in cash from financing activities resulted primarily from lower net payments related to our long-term bonds.

We currently have approximately $3.5 million outstanding under industrial revenue bonds which we previously used for the purchase and renovation of our Clearwater, Florida facility. These bonds were refinanced in October 2011 through PNC Bank, N.A. The bonds, which are being amortized over a 20-year term, balloon in November 2018 and bear interest at a fixed interest rate of 5.6%. Scheduled maturities of this indebtedness are $33,300, $137,300, $145,000, $153,100 and $161,700 for 2012, 2013, 2014, 2015 and 2016, respectively and approximately $2.8 million thereafter.

We had approximately $4.5 million in cash and cash equivalents at September 30, 2012. 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 twelve months. Should additional funds be required, we have secured additional borrowing capacity with PNC Bank (See below).

We have a $6 million secured revolving line of credit facility with PNC Bank, which at September 30, 2012 had a zero balance. Advances under the $6 million line of credit are due on demand and bear interest at a rate of daily LIBOR plus 1.75% and are secured by a perfected first security interest in our inventory and accounts receivable.

In addition we have a separate credit facility with PNC Bank for up to $1 million for financing new equipment purchases. This credit facility provides for a 1 year draw up to the conversion date of October 31, 2013. Prior to the conversion dates amounts outstanding will bear an interest rate of daily LIBOR plus 2.25%. Once the note is converted the term will be 5 years and will bear an interest rate of daily LIBOR plus 2.50%. The note would be secured by a perfected first security interest in the new equipment purchased.

Subsequent available borrowings for both these credit facilities are subject to a borrowing base utilizing a percentage of eligible receivables, inventories, and any assigned cash along with certain financial ratios, specifically maintaining: (i) a ratio of tangible net worth of less than 0.75 to 1.0 and (ii) a ratio of minimum fixed charge of 1.25 to 1.0 measured on a rolling four quarter basis.

At September 30, 2012, 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 $3.7 million total availability under the $6 million credit line, of which we currently have a zero balance. We also have available approximately $1.0 million under the equipment line of credit.

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, 2012 | 2013 | 2014 | 2015 | 2016 | 2017 |
| --- | ---: | ---: | ---: | ---: | ---: | ---: |
| Operating leases | $64 | $228 | $12 | $- | - | - |
| Employment agreements | 160 | 642 | 48 | - | - | - |
| Purchase Commitments | 2,295 | 1,562 | - | - | - | - |

### 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 report on Form 10-K for the year ended December 31, 2011, which we filed in March 2012.

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, fair valued liabilities, 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

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 (see Note 6).

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, anti-dilution 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 our stock option plan, options to purchase common shares of common stock of the Company may be granted to our key employees, officers, directors and consultants by the Board of Directors. We account 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 have net operating loss and tax credit carry-forwards available in certain jurisdictions 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 taxes, 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 September 30, 2012, 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.

Since inception, we have been subject to tax by both federal and state taxing authorities. Until the respective statutes of limitations expire (which maybe as much as 20 years while we have unused net operating loss carry-forwards), we are subject to income tax audits in the jurisdictions in which we operate.

#### Inflation

Inflation has not materially impacted the operations of our company.

#### Off-Balance Sheet Arrangements

We have no off-balance sheet arrangements at this time.

#### Recent Accounting Pronouncements

See Note 4.

## Market risk

As filed, 600 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 September 30, 2012, this change would not have had a material effect on the fair value of our investment portfolio as of that date.

## Controls and procedures

As filed, 1,774 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 September 30, 2012. Based upon that evaluation, our CEO and CFO concluded that, as of the end of that period, 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 September 30, 2012 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

## Risk factors

As filed, 178 characters.

There have been no material changes to the risk factors previously disclosed in our Form 10-K for the year ended December 31, 2011, in response to Item 1A to Part 1 of Form 10-K.

Filed Nov 14, 2012.
Source: SEC EDGAR, the filing index for accession 0001140361-12-046982. Last ingested by Listed: Nov 5, 2026, 13:09 ET. No prices; not investment advice.