# Apyx Medical Corp: Form 10-Q for the period ended Jun 30, 2013

- Company: [Apyx Medical Corp](/companies/apyx.md) (CIK 719135)
- Form: 10-Q
- Filed: 2013-08-14
- Accepted by EDGAR: Aug 14, 2013, 07:06 ET
- Period: 2013-06-30
- Accession: 0001477932-13-003628
- Inline XBRL: yes
- Main document: https://www.sec.gov/Archives/edgar/data/719135/000147793213003628/bvx_10q.htm
- All documents and exhibits: https://www.sec.gov/Archives/edgar/data/719135/000147793213003628/

## Figures reported in this filing

Standardized XBRL line items for the period ended 2013-06-30.

| Line item | Period | Value | XBRL concept |
| --- | --- | ---: | --- |
| Revenue | 6 months, 2013-01-01 to 2013-06-30 | $11.7m | us-gaap:SalesRevenueNet |
| Cost of revenue | 3 months, 2013-04-01 to 2013-06-30 | $3.8m | us-gaap:CostOfGoodsAndServicesSold |
| Cost of revenue | 6 months, 2013-01-01 to 2013-06-30 | $7.4m | us-gaap:CostOfGoodsAndServicesSold |
| Gross profit | 3 months, 2013-04-01 to 2013-06-30 | $2.2m | us-gaap:GrossProfit |
| Gross profit | 6 months, 2013-01-01 to 2013-06-30 | $4.4m | us-gaap:GrossProfit |
| Research and development | 3 months, 2013-04-01 to 2013-06-30 | $314.0k | us-gaap:ResearchAndDevelopmentExpense |
| Research and development | 6 months, 2013-01-01 to 2013-06-30 | $647.0k | us-gaap:ResearchAndDevelopmentExpense |
| Selling, general and administrative | 3 months, 2013-04-01 to 2013-06-30 | $1.3m | us-gaap:SellingGeneralAndAdministrativeExpense |
| Selling, general and administrative | 6 months, 2013-01-01 to 2013-06-30 | $2.5m | us-gaap:SellingGeneralAndAdministrativeExpense |
| Operating income | 3 months, 2013-04-01 to 2013-06-30 | −$1.6m | us-gaap:OperatingIncomeLoss |
| Operating income | 6 months, 2013-01-01 to 2013-06-30 | −$2.3m | us-gaap:OperatingIncomeLoss |
| Income tax | 3 months, 2013-04-01 to 2013-06-30 | −$554.0k | us-gaap:IncomeTaxExpenseBenefit |
| Income tax | 6 months, 2013-01-01 to 2013-06-30 | −$898.0k | us-gaap:IncomeTaxExpenseBenefit |
| Net income | 3 months, 2013-04-01 to 2013-06-30 | −$1.1m | us-gaap:NetIncomeLoss |
| Net income | 6 months, 2013-01-01 to 2013-06-30 | −$1.5m | us-gaap:NetIncomeLoss |
| Diluted EPS | 3 months, 2013-04-01 to 2013-06-30 | −$0.06 | us-gaap:EarningsPerShareDiluted |
| Diluted EPS | 6 months, 2013-01-01 to 2013-06-30 | −$0.09 | us-gaap:EarningsPerShareDiluted |
| Basic EPS | 3 months, 2013-04-01 to 2013-06-30 | −$0.06 | us-gaap:EarningsPerShareBasic |
| Basic EPS | 6 months, 2013-01-01 to 2013-06-30 | −$0.09 | us-gaap:EarningsPerShareBasic |
| Diluted shares (weighted) | 3 months, 2013-04-01 to 2013-06-30 | 17,669 shares | us-gaap:WeightedAverageNumberOfDilutedSharesOutstanding |
| Diluted shares (weighted) | 6 months, 2013-01-01 to 2013-06-30 | 17,660 shares | us-gaap:WeightedAverageNumberOfDilutedSharesOutstanding |
| Operating cash flow | 6 months, 2013-01-01 to 2013-06-30 | −$1.3m | us-gaap:NetCashProvidedByUsedInOperatingActivities |
| Capital expenditure | 6 months, 2013-01-01 to 2013-06-30 | $293.0k | us-gaap:PaymentsToAcquirePropertyPlantAndEquipment |
| Cash and equivalents | at 2013-06-30 | $2.6m | us-gaap:CashAndCashEquivalentsAtCarryingValue |
| Current assets | at 2013-06-30 | $14.8m | us-gaap:AssetsCurrent |
| Total assets | at 2013-06-30 | $27.9m | us-gaap:Assets |
| Current liabilities | at 2013-06-30 | $3.0m | us-gaap:LiabilitiesCurrent |
| Total liabilities | at 2013-06-30 | $6.2m | us-gaap:Liabilities |
| Shareholders' equity | at 2013-06-30 | $21.7m | us-gaap:StockholdersEquity |

## Management's discussion and analysis

As filed, 41,685 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, 2012, 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 de-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 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 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 18.8% of total revenues for the first six months of 2013, as compared with 18.5% for the first six months of 2012. 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 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.

We are committed to investing in research and development, which is essential to our long-term growth strategy, in an effort to produce innovative new proprietary products. Therefore, we expect to continue to make substantial investments in the development and marketing of our J-Plasma™ technology, which we invested an additional $585,000 during the first six months of 2013 and have invested approximately $2.2 million since June 2010. Although we anticipate that these investments will expand our sales and growth in the future, there can be no assurance on the timeframe or if the J-Plasma™ technology will produce any substantial revenue or return on investment.

### Business Challenges

### Economic conditions

Second quarter sales were negatively impacted by the completion of two large multi-year OEM contracts in 2012, a new medical device tax imposed under the Affordable Care Act of 2010, legal costs of ongoing litigations and increased costs. We are actively pursuing other OEM prospects as well as additional third party products to sell through our established distribution chain, although there can be no assurance that we will be successful. While our J-Plasma™ technology continues to get positive feedback and acceptance as we expand the awareness through increased sales and marketing expenditures, there are challenges and time delays in getting a new innovative technology through hospital purchasing committee approval channels as this process is taking substantially longer than we initially anticipated. These delays, coupled with the substantial investments we have made in J-Plasma™, have had an adverse effect on our revenues and cash flow.

### Healthcare reform

In March 2010, the Patient Protection and Affordable Care Act was enacted in the United States. This legislation includes a provision that imposes a 2.3% excise tax on the sale of certain medical devices by a manufacturer, producer or importer of such devices in the United States starting after December 31, 2012. In the first six months of 2013 the new medical device tax reduced our cash balance and increased our selling, general and administrative expenses by approximately $184,000 and we estimate that it will continue to do so annually by between $375,000 and $500,000.

### Legal claims

For various reasons we have been subject to extensive litigation costs over the past several years in an effort to protect and defend the Company and our products, which has negatively impacted our cash position as well as our profitability. The timing and prolonged nature of these legal costs are occurring at a disadvantageous time given the above mentioned challenges to our business and our attempts to expand the launch of our J-Plasma™ technology, however it is necessary that we diligently continue our defenses. During the three and six months ended June 30, 2013, we accrued $1.041 million of expense related to the jury verdict in favor of Mr. Keen. (See Legal Matter disclosed in Results of Operations)

### Results of Operations –Three and Six Months Ended June 30, 2013 Compared to Three and Six Months Ended June 30, 2012

#### Sales

*(in thousands)*

| Sales by Product Line | Three months ended June 30, 2013 | 2012 | Percent change | Six months ended June 30, 2013 | 2012 | Percent change |
| --- | ---: | ---: | ---: | ---: | ---: | ---: |
| Electrosurgical | $3,269 | $4,940 | (33.8 ) % | $6,669 | $9,302 | (28.4 ) % |
| Cauteries | 1,738 | 1,698 | 2.4% | 3,334 | 3,303 | 1.0% |
| Other | 1,035 | 802 | 29.1% | 1,735 | 1,567 | 10.7% |
| Total | $6,042 | $7,440 | (18.8 ) % | $11,738 | $14,173 | (17.2 ) % |

| Sales by Domestic and International (in thousands) | Three months ended June 30, 2013 | 2012 | Percent change |  | Six months ended June 30, 2013 | 2012 | Percent change |  |
| --- | ---: | ---: | ---: | --- | ---: | ---: | ---: | --- |
| Domestic | $4,886 | $5,935 | (17.7 | ) % | $9,409 | $11,558 | (18.6 | ) % |
| International | 1,156 | 1,505 | (23.2 | ) % | 2,329 | 2,615 | (10.9 | ) % |
| Total | $6,042 | $7,440 | (18.8 | ) % | $11,738 | $14,173 | (17.2 | ) % |

During the three months ended June 30, 2013, sales of our cautery product line increased slightly at 2.4% or approximately $40,000, our other product line sales increased approximately $233,000 or 29.1% and we had a 33.8% decrease in sales in our electrosurgical line of products or approximately $1.7 million. We continue to see strong demand for our third party lighting systems, which is responsible for a substantial portion of the increase in our other product sales amounting to approximately $295,000 over the same period in 2012. The largest percentage and sales dollar decrease was in our electrosurgical product line which was mainly the result of an approximate $1.6 million decrease in generator orders from our OEM customers. Additional decreases in our other products category related to various different products amounting to approximately $73,000, offset by sales of approximately $11,000 in our new J-Plasma product line.

Sales during the six months ended June 30, 2013 decreased approximately $2.4 million or 17.2% compared to the same period in 2012. Sales in our electrosurgical products decreased approximately $2.6 million or 28.4% due mainly to a decrease in generator orders from our OEM customers. Cautery sales increased slightly by approximately $31,000 or 1.0%, and we continued to see a strong demand for our third party lighting systems, amounting to an increase of approximately $279,000 over the same period in 2012. Additional decreases in our other products category related to various different products amounting to approximately $127,000, offset by sales of approximately $16,000 in our new J-Plasma™ product line.

#### Gross Profit

*(in thousands)*

|  | Three months ended June 30, 2013 | 2012 | Percent of sales 2013 | 2012 | Percent change | Six months ended June 30, 2013 | 2012 | Percent of sales 2013 | 2012 | Percent change |
| --- | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: |
| Cost of sales | $3,812 | $4,584 | 63.1% | 61.6% | (16.8)% | $7,357 | $8,521 | 62.7% | 60.1% | (13.7)% |
| Gross profit | $2,230 | $2,856 | 36.9% | 38.4% | (21.9)% | $4,381 | $5,652 | 37.3% | 39.9% | (22.5)% |

Gross profit decreased as a percentage of sales by approximately 1.5% for the three month period ending June 30, 2013 and by approximately 2.6% for the six month period ending June 30, 2013 compared to the same respective periods in 2012. The decrease in our gross profit percentages for both of these periods in 2013 when compared to the same periods in 2012 was mainly due to lower overall sales coupled with our labor costs increasing by approximately 7.1%, however we did experience a reduction in material cost of approximately 2.6% as a percentage of sales.

#### Research and Development

*(in thousands)*

|  | Three months ended June 30, 2013 | 2012 | Percent of sales 2013 | 2012 | Percent change | Six months ended June 30, 2013 | 2012 | Percent of sales 2013 | 2012 | Percent change |
| --- | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: |
| R & D Expense | $314 | $349 | 5.2% | 4.7% | (10.0)% | $647 | $647 | 5.5% | 4.6% | 0.0% |

Research and development costs decreased by approximately $35,000 or 10.0% for the three month period ending June 30, 2013 compared to the same period in 2012. During the second quarter of 2013, although we continue to develop enhancements and complimentary items to our next generation of J-Plasma™ products for which we incurred increased consulting costs, we were able to reduce payroll and materials costs which resulted in an overall decrease to our research and development costs.

During the six months ended June 30, 2013, our research and development costs remained constant when compared to the same period in 2012, as increased consulting costs were offset by an equal reduction in payroll and materials cost.

#### Professional Fees

*(in thousands)*

|  | Three months ended June 30, 2013 | 2012 | Percent of sales 2013 | 2012 | Percent change 2013 | Six months ended June 30, 2012 | 2013 | Percent of sales 2012 |  | Percent change |
| --- | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: |
| Professional services | $383 | $358 | 6.3% | 4.8% | 7.0% | $836 | $653 | 7.1% | 4.6% | 28.0% |

Our professional fees increased by approximately $25,000 during the three months ended June 30, 2013 compared to the same period in 2012, mainly attributable to increased legal cost related to the ongoing litigations as outlined and described in Item 1: Legal Proceedings, which has adversely affected our cash position. In addition, we had an increase of approximately $5,000 in compensation expense related to consultants and an increase of approximately $5,000 in accounting and auditing fees, however these were offset by an approximate $3,000 decrease in consulting fees.

Our professional services costs for the six months ended June 30, 2013 increased by approximately $183,000 mainly due to increased legal fees related to existing lawsuits when compared to the same six month period in 2012.

#### Salaries

*( in thousands)*

|  | Three months ended June 30, 2013 | 2012 | Percent of sales 2013 | 2012 | Percent change | Six months ended June 30, 2013 | 2012 | Percent of sales 2013 | 2012 | Percent change |
| --- | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: |
| Salaries & related cost | $806 | $788 | 13.3% | 10.6% | 2.2% | $1,624 | $1,570 | 13.8% | 11.1% | 3.4% |

During the three months ended June 30, 2013, our salary and related costs increased 2.2% or approximately $18,000 when compared to the same period in 2012. The increase is due to a marketing position and an IT position and their related costs which were vacant in the second quarter of 2012 but both positions were filled later in 2012 resulting in the costs being present in the three month period ended June 30, 2013 but absent in the same period in 2012.

We experienced a 3.4% increase in salaries and related costs, or approximately $54,000, during the six months ending June 30, 2013 as compared to the same period in 2012. This increase was the net result of the addition of a plasma marketing position of approximately $43,000 along with salary costs in our IT department of approximately $34,000, which were offset by decreases of approximately $8,000, $5,000, and $11,000 in employee procurement costs, overtime payments and vacation accrual costs, respectively.

#### Selling, General & Administrative Expenses

*(in thousands)*

|  | Three months ended June 30, 2013 | 2012 | Percent of sales 2013 | 2012 | Percent change | Six months ended June 30, 2013 | 2012 | Percent of sales 2013 | 2012 | Percent change |
| --- | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: |
| SG & A costs | $1,336 | $1,121 | 22.1% | 15.1% | 19.2% | $2,548 | $2,146 | 21.7% | 15.1% | 18.7% |

20

Selling, general and administrative costs increased approximately $215,000 or 19.2% for the three month period ending June 30, 2013 as compared to the same period in 2012. Our sales and marketing related costs increased by approximately $26,000 which included reductions on our distribution side of our business and increased costs diverted to the promotion and marketing of our J-Plasma™ products. The medical supplies excise tax instituted by the Affordable Care Act amounted to an increase of approximately $96,000 as this tax was not in effect during the same period in 2012. We experienced an increase in our general liability insurance of approximately $52,000. Additional increases in our general costs were approximately $21,000 in computer related expenses, approximately $8,000 in our regulatory testing related to our effort to become Dash 3 compliant, and approximately $22,000 in shareholder related expenses due to the timing of the annual meeting. However, we did have a reduction of approximately $10,000 in amortization expense.

For the six months ending June 30, 2013 selling, general and administrative costs increased approximately $402,000 or 18.7% as compared to the same period in 2012. Our sales and marketing related costs increased by approximately $81,000 which included reductions on our distribution side of our business and increased costs diverted to the promotion and marketing of our J-Plasma products. The medical supplies excise tax instituted by the Affordable Care Act amounted to an increase of approximately $184,000 as this tax was not in effect and absent during the same period in 2012. We experienced an increase in our general liability insurance of approximately $66,000. Additional increases in our general costs amounted to approximately $108,000 which included increases in computer related expenses, regulatory testing related to our effort to become Dash 3 compliant, shareholder related expenses, various other overhead related costs, and a reduction in recoveries of obsolesence. However, we did have reductions of approximately $26,000 in amortization expense and $11,000 in royalty fees paid.

#### Legal matter

In connection with the previously disclosed litigation pending in the United States District Court for the Middle District of Florida between the Company and Leonard Keen, the Company’s former Vice President and General Counsel, on August 8, 2013, following a jury trial, the jury returned a verdict in favor of Mr. Keen awarding him $622,500 in severance. In addition, the jury determined that, Mr. Keen’s previously issued 110,000 stock options should be reinstated and accelerated, and that the Company must indemnify Mr. Keen for any damages or costs he suffered in his capacity as an employee of Bovie pursuant to the terms of Mr. Keen’s prior employment agreement with the Company. Lastly, Mr. Keen was awarded attorney’s fees in an amount to be determined by the Court. The Company is presently reviewing its options as they pertain to the verdict.

Because the verdict was received prior to the issuance of this report on Form 10-Q, we have accrued a charge of approximately $1.041 million as of June 30, 2013.

#### Other Income (expense)

*(in thousands)*

|  | Three months ended June 30, 2013 | 2012 | Percent of sales 2013 | 2012 | Percent change | Six months ended June 30, 2013 | 2012 | Percent of sales 2013 | 2012 | Percent change |
| --- | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: |
| Interest income (expense) | $(60) | $(58) | (1.0)% | (0.8)% | 3.4% | $(116) | $(116) | (1.0)% | (0.8)% | 0.0% |
| Change in fair value of derivative liabilities | $37 | $44 | 0.6% | 0.6% | (15.9)% | $4 | $27 | 0.0% | 0.2% | (85.2)% |

As a result of the change in fair value of the warrants associated with the equity issuance in April 2010, we recorded a non-cash gain of approximately $37,000 for the three months ended June 30, 2013 compared to a non-cash gain of approximately $44,000 for the same three month period in 2012, resulting in a change of approximately $7,000. The derivative warrant liability was valued at approximately $85,000 at December 31, 2012 and was valued at approximately $81,000 at June 30, 2013.

For the three and six-month period ended June 30, 2013 as compared to the same period in 2012, net interest expense remained unchanged.

#### Income Taxes

*(in thousands)*

|  | Three months ended June 30, 2013 | 2012 | Percent of sales 2013 | 2012 | Percent change | Six months ended June 30, 2013 | 2012 | Percent of sales 2012 | 2011 | Percent change |  |
| --- | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: | --- |
| Income (loss) before income taxes | $(1,673) | $226 | (27.7)% | 3.0% | (839.4)% | $(2,427) | $547 | (20.7)% | 3.9% | (544.0 | ) % |
| Benefit (provision) for taxes | $554 | $(74) | 9.2% | (1.0)% | (848.8)% | $898 | $(208) | 7.7% | (1.5)% | (532.8 | ) % |
| Effective tax rate | 33.2% | 32.2% |  |  |  | 37.0% | 37.2% |  |  |  |  |

While we are subject to U.S. federal income tax as well as income tax of certain state jurisdictions, during the three month and six month periods ended June 30, 2013, our current provisions were zero because the net effect of our permanent and temporary differences resulted in us recognizing losses for tax purposes. At June 30, 2013, we have remaining net operating loss carry-forwards of approximately $6.7 million to reduce any future taxable income earned in various years through the tax year 2030. Our effective tax rate of (33.2%) for the three months ended June 30, 2013 was different than the statutory tax rates primarily because we recognized certain temporary and permanent adjustments for financial statement purposes.

#### Net Income

*(in thousands)*

|  | Three months ended June 30, 2013 | 2012 | Percent of sales 2013 | 2012 | Percent change 2013 | Six months ended September 30, 2012 | 2013 | Percent of sales 2012 |  | Percent change |
| --- | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: |
| Net income (loss) | $(1,119) | $152 | (18.5)% | 2.0% | (834.8)% | $(1,529) | $339 | (13.0)% | 2.4% | (550.8)% |

### 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 have historically played 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 our manufacturing location maintain relationships with distribution locations and customers to provide an understanding of changes in the market and product needs. During the first six months of 2013, we continued to invest in expanding and enhancing our J-Plasma™ product line and technology, ICON VS™ and the accompanying vessel sealing technology. 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 have a 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 June 30, 2013 decreased by approximately $2.5 million to $11.8 million compared to approximately $14.3 million at December 31, 2012. This decrease was mainly the result of an increase in inventory, and fixed asset purchases coupled with a decrease in receivables and increases in payables and accruals. Accounts receivable days of sales outstanding were 38.5 days and 39.4 days at June 30, 2013 and 2012, 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 45 days to 263 days equating to an inventory turn ratio of 1.3 at June 30, 2013 from 218 days and an inventory turn ratio of 1.4 at December 31, 2012. The higher number of days worth of sales is mainly due to increased inventory purchases related to our new J-Plasma™ line of products during the six month period ended June 30, 2013.

We used cash in operations of approximately $1.3 million for the six months ended June 30, 2013, compared to cash provided by operations of approximately $0.4 million for the same period in 2012, an increase in cash used of approximately $1.7 million.

During the six month period ended June 30, 2013, we used approximately $293,000 for the purchase of property and equipment as compared to purchases amounting to approximately $287,000 for the same period in 2012.

We used cash in financing activities of approximately $44,000 during the first six months of 2013, a decrease of cash used of approximately $20,000 as compared with the same period in 2012. The decrease in cash used resulted primarily from the repayment of long term debt offset by our receipt of funds from individuals related to the exercise of stock options during the six months ended June 30, 2013.

We currently have approximately $3.4 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 have a 20-year amortization term, balloon in November 2018 and bear interest at a fixed interest rate of 5.6%. Scheduled maturities of this indebtedness are approximately $74,000, $146,000, $154,000, $164,000 and $172,000 for 2013, 2014, 2015, 2016 and 2017, respectively and approximately $2.6 million thereafter.

We are continuing to make substantial investments in the development and marketing of our J-Plasma™ technology, which may adversely affect our profitability and cash flow in the next 12 to 24 months. While we believe that these investments may generate additional revenues and profits in the future, there can be no assurance that J-Plasma will be successful or that such future revenues and profitability will be realized. Since June 2010 through June 30, 2013, we have invested approximately $2.2 million in the development and marketing of our J-Plasma™ technology. We continue to receive positive feedback from a variety of surgeons who use the J-Plasma™ instruments for the first time in our labs and other demonstrations, however, we have experienced longer than anticipated time frames between committee meetings related to the process to obtain approval from hospital purchasing committees. These longer time frames have delayed our previously anticipated sales of J-Plasma™ instruments including sales to hospitals with surgeons who have recently conveyed an interest in purchasing and using our instruments. These events, coupled with the factors described in the previous sentences, have had an adverse effect on our cash position.

We had approximately $2.6 million in cash and cash equivalents at June 30, 2013. While 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, due to the factors described above, we may seek additional capital from the capital markets in order to provide the necessary capital to market and distribute our J-Plasma™ products. Additionally, we maintain a revolving line of credit with PNC Bank should additional funds be required (See below).

On April 18, 2013, we entered into an amendment to our revolving line of credit with PNC Bank which had an effective date of March 30, 2013. Pursuant to the amendment, we have a $4 million secured revolving line of credit facility with PNC Bank, which at June 30, 2013 had a zero balance. Advances under the $4 million line of credit are due on demand and bear interest at a rate of daily LIBOR plus 2.25% and are secured by a perfected first security interest in our inventory and accounts receivable.

Subsequent available borrowings for this credit facility is subject to a borrowing base utilizing a percentage of eligible receivables, inventories, and any assigned cash along with certain financial ratios. Pursuant to the terms of the Amendment to Credit Documents, we are required, among other things, to maintain a minimum Adjusted EBITDA in at least the following amounts, for the following periods: (a) ($525,000) for the three months including March 31, 2013; (b) ($1,100,000) for the six months ending June 30, 2012; (c) ($1,400,000) for the nine months ended September 30, 2013; and (d) ($1,400,000) for the twelve months ended December 31, 2013. We must also maintain a Fixed Charge Coverage Ratio of at least the following at the end of the following periods: (i) 1.25:1.0 for the three months ended March 31, 2014; (ii) 1.25:1.0 for the six months ended June 30, 2014; (iii) 1.25:1.0 for the nine months ended September 30, 2014; and (iv) 1.25:1.0 for the twelve months ended December 31, 2014 and for the last twelve months ending as of the end of each fiscal quarter thereafter.

Because of the accrued liability we booked in the quarter related to the August 8, 2013 verdict in the Keen case, we are no longer in compliance with the financial covenants with PNC Bank. We are currently working to resolve the non compliance with PNC Bank. According to our most recent borrowing base calculation, we had approximately $3.5 million total availability under the $4 million credit line, under which we currently have a zero balance. Based upon the non compliance mentioned above, we will be unable to draw down on the line until we get the matter resolved with the PNC. We anticipate a resolution prior to the end of the next quarter.

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, 2013 | 2014 | 2015 | 2016 | 2017 | 2018 |
| --- | ---: | ---: | ---: | ---: | ---: | ---: |
| Operating leases | $100 | $12 | $- | $- | $- | $- |
| Employment agreements | 483 | 846 | 786 | - | - | - |
| Purchase commitments | 2,165 | 858 | - | - | - | - |
| Consulting contracts | 36 | 72 | - | - | - | - |
| Long-term debt | 74 | 146 | 154 | 164 | 172 | 2,646 |
| Total | $2,858 | $1,934 | $940 | $164 | $172 | $2,646 |

### 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, 2012, which we filed on April 1, 2013.

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 5).

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.

#### Stock-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.

#### Litigation Contingencies

From time to time, we are exposed to claims and litigation arising in the ordinary course of business and use various methods to resolve these matters in a manner that we believe serves the best interest of the Company and our stockholders. There can be no assurance these actions or other third party assertions will be resolved without costly litigation, or in a manner that is not adverse to our financial position. Other than the Keen matter described below, we do not believe that any of the currently identified claims or litigation matters will have a material adverse impact on our results of operations, cash flows or financial condition. However, given uncertainties associated with any litigation, if our assessments prove to be wrong, or if additional information becomes available such that we estimate that there is a possible loss or possible range of loss associated with these contingencies, then we would record the minimum estimated liability, which could materially impact our results of operations, financial position and cash flows. On August 8, 2013 we received a jury verdict on the Keen matter which we have accrued approximately $1.041 million as of June 30, 2013.

#### 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 June 30, 2013, 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, 595 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, 2013, 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, 1,764 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, 2013. 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 June 30, 2013 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, 2012, in response to Item 1A to Part 1 of Form 10-K.

Filed Aug 14, 2013.
Source: SEC EDGAR, the filing index for accession 0001477932-13-003628. Last ingested by Listed: Nov 5, 2026, 13:09 ET. No prices; not investment advice.