Notes to Condensed Consolidated Financial
Statements
For the Three Months Ended September
30, 2018 and 2017 (unaudited)
1. Basis of Presentation, Organization
and Business and Summary of Significant Accounting Policies
Basis of Presentation
These condensed consolidated financial
statements of Misonix, Inc. (“Misonix” or the “Company”) include the accounts of Misonix and its 100% owned
subsidiaries. All significant intercompany balances and transactions have been eliminated.
The accompanying unaudited condensed consolidated
financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America
(“U.S. GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation
S-X. Accordingly, these financial statements do not include all the information and footnotes required by U.S. GAAP for complete
financial statements. As such, they should be read with reference to the Company’s Annual Report on Form 10-K for the fiscal
year ended June 30, 2018, which provides a more complete explanation of the Company’s accounting policies, financial position,
operating results, business properties and other matters. In the opinion of management, these financial statements reflect all
adjustments considered necessary for a fair statement of interim results.
Organization and Business
Misonix designs, manufactures and markets
minimally invasive therapeutic ultrasonic medical devices. These products are used for precise bone sculpting, removal of soft
and hard tumors, and tissue debridement, primarily in the areas of neurosurgery, orthopedic surgery, plastic surgery, wound care
and maxillo-facial surgery. In the United States, our products are marketed primarily through a hybrid sales approach. This includes
direct sales representatives, managed by regional sales managers, along with independent distributors. Outside the United States,
we sell BoneScalpel and SonaStar to specialty distributors who purchase products from us to resell to their clinical customer bases.
We sell to all major markets in the Americas, Europe, Middle East, Asia Pacific and Africa. The Company operates as one business
segment.
High Intensity Focused Ultrasound
Technology
The Company sold its rights to the
high intensity focused ultrasound technology to SonaCare Medical, LLC (“SonaCare”) in May 2010. The Company may
receive up to approximately $5.8 million in payment for the sale. SonaCare will pay the Company 7% of the gross revenues
received from its sales of the (i) prostate product in Europe and (ii) kidney and liver products worldwide, until the Company
has received payments of $3 million, and thereafter 5% of the gross revenues, up to an aggregate payment of $5.8 million, all
subject to a minimum annual royalty of $250,000. No payments were received for the three months ended September 30, 2018 and
2017. Cumulative royalties through September 30, 2018 were $2,542,579.
Major Customers and Concentration of
Credit Risk
Included in revenues are sales to the Company
distributor of Bone Scalpel in China of approximately $1,500,000 and $0, for the three months ended September 30, 2018 and 2017,
respectively. Accounts receivable from this customer were $10,000 and $0 at September 30, 2018 and June 30, 2018, respectively.
Total royalties from Medtronic Minimally
Invasive Therapies (“MMIT”) related to their sales of the Company’s ultrasonic cutting and sculpting products,
which use high frequency sound waves to coagulate and divide tissue for both open and laparoscopic surgery, were $0 and $453,000
for the three months ended September 30, 2018 and 2017, respectively. Accounts receivable from MMIT royalties were $0 at September
30, 2018 and $0 at June 30, 2018. The license agreement with MMIT expired in August 2017.
At September 30, 2018 and June 30, 2018, the Company’s
accounts receivable with customers outside the United Sates were approximately $1,689,000 and $1,630,000, respectively, $370,000 of
which is over 90 days at September 30, 2018.
Earnings Per Share
Earnings per share (“EPS”)
is calculated using the two class method, which allocates earnings among common stock and participating securities to calculate
EPS when an entity’s capital structure includes either two or more classes of common stock or common stock and participating
securities. Unvested share-based payment awards that contain non-forfeitable rights to dividends or dividend equivalents (whether
paid or unpaid) are participating securities. As such, unvested restricted stock of the Company are considered participating securities.
The dilutive effect of options and their equivalents (including non-vested stock issued under stock based compensation plans),
is computed using the “treasury” method.
Basic income per common share is based
on the weighted average number of common shares outstanding during the period. Diluted income per common share includes the dilutive
effect of potential common shares outstanding. The following table sets forth the reconciliation of weighted average shares outstanding
and diluted weighted average shares outstanding:
|
|
For the three months ended
|
|
|
|
September 30,
|
|
|
|
2018
|
|
|
2017
|
|
|
|
|
|
|
|
|
Basic weighted average shares outstanding
|
|
|
9,100,123
|
|
|
|
8,958,405
|
|
Dilutive effect of resticted stock awards (participating securities)
|
|
|
—
|
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
Denominator for basic earnings per share
|
|
|
9,100,123
|
|
|
|
8,958,405
|
|
|
|
|
|
|
|
|
|
|
Dilutive effect of stock options
|
|
|
—
|
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
Diluted weighted average shares outstanding
|
|
|
9,100,123
|
|
|
|
8,958,405
|
|
Diluted EPS for the three months ended
September 30, 2018 and 2017 as presented is the same as basic EPS as the inclusion of the effect of common share equivalents then
outstanding would be anti-dilutive. Accordingly, excluded from the calculation of diluted EPS are the dilutive effect of options
to purchase 632,301 and 668,751 shares of common stock for the three months ended September 30, 2018 and 2017, respectively. Also
excluded from the calculation of earnings per share for the three months ended September 30, 2018 and 2017 are the unvested restricted
stock awards which were issued in December 2016.
Recent Accounting Pronouncements
In May 2014, the Financial
Accounting Standards Board (the “FASB”) issued ASC Update No. 2014-09, Revenue from Contracts with Customers
(Topic 606), which was subsequently updated. The purpose of the updated standard is to provide enhancements to the quality
and consistency of revenue recognition between companies using U.S. GAAP and International Financial Reporting Standards. The
new five-step recognition model introduces the core principle of recognizing revenue in an amount that reflects the
consideration to which the entity expects to be entitled in exchange for the promised goods or services, which includes
additional footnote disclosures to describe the nature, amount, timing and uncertainty of revenue, certain costs and cash
flow arising from customers.
As amended, ASU 2014-09 requires
the Company to use either of the following transition methods: (i) a full retrospective approach reflecting the application
of the standard in each prior reporting period with the option to elect certain practical expedients; or (ii) a
modified retrospective approach with the cumulative effect of initially adopting ASU 2014-09 recognized at the date of
adoption. This standard became effective for the Company on July 1, 2018 and the Company adopted the new pronouncement under
the modified retrospective approach.
In February 2016, the FASB issued guidance
on lease accounting requiring lessees to recognize a right-of-use asset and a lease liability for long-term leases. The liability
will be equal to the present value of lease payments. This guidance must be applied using a modified retrospective transition approach
to all annual and interim periods presented and is effective for the Company beginning in fiscal 2020. The Company is currently
in the early stages of evaluating this guidance to determine the impact it will have on its consolidated financial statements.
In August 2016, the FASB issued guidance
on the Statement of Cash Flows Classification of certain cash receipts and cash payments (a consensus of the Emerging Issues Task
Force). This guidance addresses the following eight specific cash flow issues: Debt prepayment or debt extinguishment costs; settlement
of zero-coupon debt instruments or other debt instruments with coupon interest rates that are insignificant in relation to the
effective interest rate of the borrowing; contingent consideration payments made after a business combination; proceeds from the
settlement of insurance claims; proceeds from the settlement of corporate-owned life insurance policies (including bank-owned life
insurance policies); distributions received from equity method investees; beneficial interests in securitization transactions;
and separately identifiable cash flows and application of the predominance principle. This guidance became effective for the Company
beginning in fiscal 2019. As this guidance only affects the classification within the statement of cash flows, ASU 2016-15 did
not have a material impact on the Company’s consolidated financial statements.
In January 2017, the FASB issued ASU No.
2017-01,
Business Combinations: Clarifying the Definition of a Business
(“ASU 2017-01”). ASU 2017-01 clarifies
the definition of a business for determining whether transactions should be accounted for as acquisitions (or disposals) of assets
or businesses. ASU 2017-01 is effective for annual periods and interim periods within those annual periods beginning after December
15, 2017, and early adoption is permitted. The Company adoption of ASU 2017-01 did not have a material effect on the Company’s
consolidated financial statements.
There are no other recently issued accounting
pronouncements that are expected to have a material effect on the Company’s financial position, results of operations or
cash flows.
Critical Accounting Policies and Use of Estimates
Use of Estimates
The preparation of financial statements
in conformity with accounting principles generally accepted in the United States requires management to make estimates and judgments
that affect the reported amount of assets and liabilities and disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses during the reporting period. Significant estimates and assumptions
are used for but not limited to establishing the allowance for doubtful accounts, valuation of inventory, depreciation, asset impairment
evaluations and establishing deferred tax assets and related valuation allowances, and stock-based compensation. Actual results
could differ from those estimates.
2. Revenue Recognition
On July 1, 2018 the Company adopted
Topic 606 using the modified retrospective method applied to those contracts which were not completed as of the adoption
date. The reported results for the quarter ended September 30, 2018 reflect the application of Topic 606 guidance
while the reported results for fiscal year 2018 were prepared under the guidance of Topic 605,
“Revenue Recognition”. The adoption of Topic 606 resulted in a cumulative prior period adjustment in the amount
of $960,000 related to the Company’s License and Exclusive Manufacturing Agreement described below, but the remainder
of the adoption did not have a material impact on the timing or amount of revenue recognized.
The impacts of adopting ASC Topic 606 on
the Company’s consolidated balance sheets as of July 1, 2018 were as follows:
|
|
|
|
|
|
|
|
As
|
|
|
|
|
|
|
|
|
|
Adjusted
|
|
|
|
As
|
|
|
ASC 606
|
|
|
Under
|
|
|
|
Reported
|
|
|
Adjustments
|
|
|
ASC 606
|
|
|
|
|
|
|
|
|
|
|
|
Long-term contract assets
|
|
$
|
—
|
|
|
$
|
960,000
|
|
|
$
|
960,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Shareholders’ equity
|
|
$
|
24,401,178
|
|
|
$
|
960,000
|
|
|
$
|
25,361,178
|
|
The Company has made the following accounting
policy elections and elected to use certain practical expedients, as permitted by the FASB, in applying Topic 606: 1) the Company
accounts for amounts collected from customers for sales and other taxes net of related amounts remitted to tax authorities; 2)
the Company expenses costs to obtain a contract as they are incurred if the expected period of benefit, and therefore the amortization
period, is one year or less; 3) the Company accounts for shipping and handling activities that occur after control transfers to
the customer as a fulfillment cost rather than an additional promised service and these fulfillment costs fall within selling,
general and administrative expenses; 4) the Company does not assess whether promised goods or services are performance obligations
if they are immaterial in the context of the contract with the customer; 5) the Company will utilize the right-to-invoice practical
expedient with regard to the recognition of revenue upon the purchase of consumable goods in connection with a product placement/consignment
arrangement.
The Company determines revenue recognition
through the following steps:
|
●
|
Identification of the contract, or contracts, with a customer
|
|
●
|
Identification of the performance obligations in the contract
|
|
●
|
Determination of the transaction price
|
|
●
|
Allocation of the transaction price to the performance obligations in the contract
|
|
●
|
Recognition of revenue when, or as, a performance obligation is satisfied
|
Contracts and Performance Obligations
The Company accounts for a contract with
a customer when there is an approval and commitment from both parties, the rights of the parties are identified, payment terms
are identified, the contract has commercial substance and collectability of the consideration is probable. The Company’s
performance obligations consist mainly of transferring control of products and related services identified in the contracts, purchase
orders or invoices. For each contract, the Company considers the obligation to transfer products or bundled products and services
to the customer, of which each is distinct in the context of the contract, to be performance obligations. The Company historically
has not made provisions for returns and allowances as they have not been material to the operations of the Company.
Transaction Price and Allocation to Performance Obligations
Transaction prices of products are typically
based upon contracted rates as specified on the purchase order for the purchase of consumables which represents the standalone
selling price as determined through the sale of products and or bundled products or services separately in similar circumstances
to similar customers. The Company determines the effects of variable consideration, inclusive of any constraints, in determining
the transaction price with regard to their contracts with customers.
Recognition of Revenue
The Company satisfies performance obligations
over time, or at a point in time, upon which control transfers to the customer.
Revenue
derived from the shipping and billing of product is recorded upon shipment, when transfer of control for products shipped F.O.B.
shipping point. Products shipped F.O.B. destination point are recorded as revenue when received at the point of destination when
the transfer of control is completed. Shipments under agreements with distributors are not subject to return, and payment for
these shipments in not contingent on sales by the distributor. Accordingly, the Company recognizes revenue on shipments to distributors
in the same manner as with other customers under the ship and bill process.
Revenue
derived from the rental of equipment is recorded on a monthly basis over the term of the lease. Shipments of consumable products
to these rental customers is recorded as orders are received and shipments are made F.O.B. destination or F.O.B. shipping point.
Revenue
derived from consignment agreements is earned as consumables product orders are fulfilled. Therefore, revenue is recognized as
shipments are made F.O B shipping point or F.O.B destination.
Revenue
derived from service and maintenance contracts is recognized evenly over the life of the service agreement as the services are
performed.
Contract
Specific Performance Obligations and Significant Judgements
Product
Placement/Consignment Agreements
The
Company’s product placement/consignment agreements include the placement of a generator at the customer’s place of
business and pricing related to the purchase of consumables for use in conjunction with the generator. These agreements have no
stated minimum consumable purchase quantities nor a stated term. The Company considers the transaction price in these arrangements
to be fully constrained variable consideration because it is dependent on future sales of consumables to the customer. The Company
has determined that the pattern of purchase of consumables by a customer is consistent with the benefit received by the customer
for the use of the generator and therefore the Company has a right to consideration based upon the pattern of consumable purchases
placed through purchase orders by the customer. The Company’s invoices to these customers have short-term payment terms
and are aligned with the transfer of goods and services to the customer and the Company recognizes revenue based upon their right
to invoice customers.
License
and Manufacturing Agreement
On
October 19, 2017, the Company entered into a License and Exclusive Manufacturing Agreement (the “Agreement”) with
Hunan Xing Hang Rui Kang Bio-technologies Co., Ltd, a Chinese corporation (the “Licensee”) under which Misonix has
licensed certain manufacturing and distribution rights to its SonaStar product line in China, Hong Kong and Macau in exchange
for payments consisting of initial payments totaling $5,000,000 for the transfer of functional intellectual property and initial
stocking orders of product, and minimum royalty payments of $2,000,000 per calendar year for three years beginning in 2019, based
upon the manufacture of products by the Licensee. $5,000,000 of initial revenue was collected and recorded for the quarter ended
March 31, 2018 under ASC 605. Upon the adoption of Topic 606, the Company evaluated this contract under the provisions of the
new revenue standard. The Company determined that the satisfied performance obligations and allocation of the transaction price
related to the $5,000,000 received prior to adoption was consistent with the provisions of ASC 606 and also recorded a transitional
adjustment to accumulated deficit in the amount of $960,000 as follows:
Minimum
royalty revenue provided by the contract
|
|
$
|
6,000,000
|
|
|
|
|
|
|
Implicit
price concession
|
|
|
(5,040,000
|
)
|
|
|
|
|
|
Adoption
adjustment to accumulated deficit under ASC 606
|
|
$
|
960,000
|
|
Although
the contract includes minimum royalties, the Company concluded that a significant portion of those guaranteed minimums are actually
variable consideration subject to the constraint because the Company has provided an implicit price concession. Specifically,
the fact that production of the product in China is not assured and the Licensee must develop a manufacturing process, coupled
with the fact that new technology related to this product is expected to be available for sale domestically, may result in the
Licensee not earning sufficient revenue in order to pay the minimum royalties. Therefore, the Company has determined variable
consideration through utilization of the most likely method based upon forecasts and projections of shipment of products.
The
Company will monitor facts and circumstances over time and adjust management’s most likely estimate of variable consideration
on a quarterly basis.
Disaggregation
of Revenue
The
Company generates revenue from the sale and leasing of medical equipment and from the sale of consumable products used
with such equipment in surgical procedures as well as through product licensing arrangements. In the United States,
the Company’s products are marketed primarily through a hybrid sales approach which includes direct sales
representatives, managed by regional sales managers, along with independent distributors. Outside the United States, the
Company sells BoneScalpel and SonaStar to specialty distributors who purchase products to resell to their clinical customer
bases. The Company sells to all major markets in the Americas, Europe, Middle East, Asia Pacific, and Africa. Revenue is
disaggregated from contracts between products under ship and bill arrangements and licensing agreements, and by geography,
which the Company believes best depicts how the nature, amount, timing and uncertainty of revenues and cash flows are
affected by economic factors. The Company also provides an immaterial amount of service revenue which is recognized over
time, but not stated separately because the amounts are immaterial.
The
following table disaggregates the Company’s product revenue by classification and location:
|
|
|
For
the three months ended
|
|
|
|
|
September 30,
|
|
|
|
|
2018
|
|
|
2017
|
|
Total
|
|
|
|
|
|
|
|
Consumables
|
|
|
$
|
6,339,108
|
|
|
$
|
5,379,589
|
|
Equipment
|
|
|
|
3,022,056
|
|
|
|
1,901,134
|
|
Total
|
|
|
$
|
9,361,164
|
|
|
$
|
7,280,723
|
|
|
|
|
|
|
|
|
|
|
|
Domestic:
|
|
|
|
|
|
|
|
|
|
Consumables
|
|
|
$
|
4,825,599
|
|
|
$
|
4,134,918
|
|
Equipment
|
|
|
|
578,919
|
|
|
|
592,424
|
|
Total
|
|
|
$
|
5,404,518
|
|
|
$
|
4,727,342
|
|
|
|
|
|
|
|
|
|
|
|
International:
|
|
|
|
|
|
|
|
|
|
Consumables
|
|
|
$
|
1,513,509
|
|
|
$
|
1,244,671
|
|
Equipment
|
|
|
|
2,443,137
|
|
|
|
1,308,710
|
|
Total
|
|
|
$
|
3,956,646
|
|
|
$
|
2,553,381
|
|
There
was no license revenue for the periods presented.
The
following table disaggregates the Company’s revenue by geographic location:
|
|
Three months ended
|
|
|
|
September 30,
|
|
|
|
2018
|
|
|
2017
|
|
|
|
|
|
|
|
|
United States
|
|
$
|
5,404,518
|
|
|
$
|
4,727,342
|
|
International
|
|
|
3,956,646
|
|
|
|
2,553,381
|
|
Total Product Revenue
|
|
$
|
9,361,164
|
|
|
$
|
7,280,723
|
|
Contract
Assets
The
timing of revenue recognition, customer invoicing, and collections produces accounts receivable and contract assets on the Company’s
consolidated balance sheet. Contract liabilities are not material to the operations of the Company as of September 30, 2018. The
Company invoices in accordance with contract payment terms. Customer invoices represent an unconditional right of consideration.
When revenue is recognized in advance of customer invoicing a contract asset is recorded. Unpaid customer invoices are reflected
as accounts receivable.
The
contract asset represents an asset in conjunction with the Company’s License and Manufacturing Agreement related to the
most likely variable consideration associated with the royalty provisions in the contract. The asset is recorded as
a long-term asset as the Company believes that payment will be made on this asset in a duration to exceed one year.
Selling
Costs
Incremental
direct costs of obtaining a contract primarily include sales commissions paid to sales personnel and outside sales representatives
in connection with sales of products under ship and bill scenarios or through product placement scenarios. The expected period
of benefit of these costs is one year or less and therefore the Company has elected the practical expedient to expense such costs
in the period in which they are incurred. Typically, these costs represent shipping and handling costs and the Company accounts
for these costs as fulfillment costs and are expensed as incurred. Costs in fulfilling a contract are only capitalized as an asset
if they relate directly to an existing contract or specific anticipated contract, they generate or enhance resources of the entity
that will be used to satisfy performance obligations in the future, and they are expected to be recovered. The Company has not
identified any such costs.
3.
Fair Value of Financial Instruments
The
Company follows a three-level fair value hierarchy that prioritizes the inputs to measure fair value. This hierarchy requires
entities to maximize the use of “observable inputs” and minimize the use of “unobservable inputs.” The
three levels of inputs used to measure fair value are as follows:
Level
1: Quoted prices (unadjusted) for identical assets or liabilities in active markets as of the measurement date.
Level
2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted
prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.
Level
3: Significant unobservable inputs that reflect assumptions that market participants would use in pricing an asset or liability.
At
September 30, 2018 and June 30, 2018, all of the Company’s cash and cash equivalents, trade accounts receivable and trade
accounts payable were short term in nature, and their carrying amounts approximate fair value.
4.
Inventories
Inventories
are summarized as follows:
|
|
September 30,
|
|
|
June 30,
|
|
|
|
2018
|
|
|
2018
|
|
Raw material
|
|
$
|
3,057,058
|
|
|
$
|
3,540,205
|
|
Work-in-process
|
|
|
186,186
|
|
|
|
180,442
|
|
Finished goods
|
|
|
2,121,364
|
|
|
|
1,743,497
|
|
|
|
|
5,364,608
|
|
|
|
5,464,144
|
|
Less valuation reserve
|
|
|
(444,258
|
)
|
|
|
(444,258
|
)
|
|
|
$
|
4,920,350
|
|
|
$
|
5,019,886
|
|
5.
Property, Plant and Equipment
Depreciation
and amortization of property, plant and equipment was $333,000 and $296,000 for the three months ended September 30, 2018 and
2017, respectively. Inventory items included in property, plant and equipment are depreciated using the straight line method over
estimated useful lives of 3 to 5 years. Depreciation of generators which are consigned to customers is expensed over a 5 year
period, and depreciation is charged to selling expenses.
6.
Goodwill
Goodwill
is not amortized. The Company reviews goodwill for impairment annually and whenever events or changes indicate that the carrying
value of an asset may not be recoverable. These events or circumstances could include a significant change in the business climate,
legal factors, operating performance indicators, competition, or sale or disposition of significant assets or products. Application
of these impairment tests requires significant judgments, including estimation of cash flows, which is dependent on internal forecasts,
estimation of the long term rate of growth for the Company’s business, the useful lives over which cash flows will occur
and determination of the Company’s weighted average cost of capital. The Company primarily utilizes the Company’s
market capitalization and a discounted cash flow model in determining the fair value which consists of Level 3 inputs. Changes
in the projected cash flows and discount rate estimates and assumptions underlying the valuation of goodwill could materially
affect the determination of fair value at acquisition or during subsequent periods when tested for impairment. The Company completed
its annual goodwill impairment tests for fiscal 2018 and 2017 as of June 30 of each year. There were no triggering events identified
during the quarter ended September 30, 2018.
7.
Patents
The
costs of acquiring or processing patents are capitalized at cost. These amounts are being amortized using the straight-line method
over the estimated useful lives of the underlying assets, which is approximately 17 years. Patents, net of accumulated amortization,
totaled $773,668 and $757,447 at September 30, 2018 and June 30, 2018, respectively. Amortization expense for the three months
ended September 30, 2018 and 2017 was $34,000 and $30,000, respectively. The following is a schedule of estimated future patent
amortization expenses by fiscal year as of September 30, 2018:
2019
|
|
|
$
|
96,335
|
|
2020
|
|
|
$
|
106,103
|
|
2021
|
|
|
$
|
99,932
|
|
2022
|
|
|
$
|
67,385
|
|
2023
|
|
|
$
|
66,315
|
|
8.
Accrued Expenses and Other Current Liabilities
The
following summarizes accrued expenses and other current liabilities:
|
|
September 30,
|
|
|
June 30,
|
|
|
|
2018
|
|
|
2018
|
|
|
|
|
|
|
|
|
Accrued payroll, payroll taxes and vacation
|
|
$
|
633,656
|
|
|
$
|
351,435
|
|
Accrued bonus
|
|
|
170,596
|
|
|
|
552,988
|
|
Accrued commissions
|
|
|
484,226
|
|
|
|
742,807
|
|
Professional fees
|
|
|
36,000
|
|
|
|
102,065
|
|
Deferred foreign taxes
|
|
|
401,000
|
|
|
|
401,000
|
|
Vendor, tax and other accruals
|
|
|
619,425
|
|
|
|
661,877
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
2,344,903
|
|
|
$
|
2,812,172
|
|
9.
Stock-Based Compensation Plans
Stock
Option Awards
For
the three months ended September 30, 2018 and 2017, the compensation cost relating to stock option awards that has been charged
against income for the Company’s stock option plans was $278,121 and $398,359 respectively. As of September 30, 2018, there
was $2,996,027 of total unrecognized compensation cost related to non-vested share-based compensation arrangements to be recognized
over a weighted-average period of 2.7 years.
Stock
options typically expire 10 years from the date of grant and vest over service periods, which typically are 4 years. All options
are granted at fair market value, as defined in the applicable plans.
The
fair value of each option award was estimated on the date of grant using the Black-Scholes option valuation model that uses the
assumptions noted in the following table. The expected volatility represents the historical price changes of the Company’s
stock over a period equal to that of the expected term of the option. The Company uses the simplified method for determining the
option term. The risk-free rate was based on the U.S. Treasury yield curve in effect at the time of grant. The expected dividend
yield is based upon historical and projected dividends. The Company has historically not paid dividends, and is not expected to
do so in the near term.
The
weighted average fair value per share at date of grant for options granted during the three months ended September 30, 2018 was
$8.62. There were options to purchase 137,000 and 172,500 shares granted during the three months ended September 30, 2018 and
2017, respectively. The fair value was estimated based on the weighted average assumptions of:
|
|
For three months ended
|
|
|
|
September 30, 2018
|
|
|
|
2018
|
|
|
2017
|
|
Risk-free interest rates
|
|
|
2.87
|
%
|
|
|
1.86
|
%
|
Expected option life in years
|
|
|
6.25
|
|
|
|
5.72
|
|
Expected stock price volatility
|
|
|
55.39
|
%
|
|
|
59.52
|
%
|
Expected dividend yield
|
|
|
0
|
%
|
|
|
0
|
%
|
A
summary of option activity under the Company’s equity plans as of September 30, 2018, and changes during the three months
ended September 30, 2018 is presented below:
|
|
Outstanding
Shares
|
|
|
Average
Exercise
Price
|
|
|
Aggregate
Intrinsic Value
|
|
Outstanding at June 30, 2018
|
|
|
1,330,193
|
|
|
$
|
8.47
|
|
|
$
|
5,369,557
|
|
Granted
|
|
|
137,000
|
|
|
|
15.55
|
|
|
|
|
|
Exercised
|
|
|
(51,660
|
)
|
|
|
8.05
|
|
|
|
|
|
Forfeited
|
|
|
(55,627
|
)
|
|
|
9.16
|
|
|
|
|
|
Expired
|
|
|
(15,000
|
)
|
|
|
2.66
|
|
|
|
|
|
Outstanding as of September 30, 2018
|
|
|
1,344,906
|
|
|
$
|
9.31
|
|
|
$
|
12,364,220
|
|
Vested and exercisable at September 30, 2018
|
|
|
710,280
|
|
|
$
|
8.04
|
|
|
$
|
7,428,351
|
|
The
total fair value of stock options vested during the three months ended September 30, 2018 was $526,729. The number and weighted-average
grant-date fair value of non-vested stock options at the beginning of fiscal 2018 was 648,877 and $5.08, respectively. The number
and weighted-average grant-date fair value of stock options which vested during the three months ended September 30, 2018 was
95,624 and $5.51, respectively.
Restricted
Stock Awards
On
December 15, 2016, the Company issued 400,000 shares of restricted stock to its Chief Executive Officer. These awards vest over
a period of up to five years, subject to meeting certain service, performance and market conditions. These awards were valued
at approximately $3.6 million. Compensation expense recorded in the three months ended September 30, 2018 and 2017 related to
these awards was $726,377 and $226,934 respectively. As of September 30, 2018, there was approximately $1,552,272 of total unrecognized
compensation cost related to non-vested restricted stock awards to be recognized over a weighted-average period of 3.06 years.
The awards contain a combination of vesting terms which include time vesting, performance vesting relating to revenue achievement,
and market vesting related to obtaining certain levels of Company stock prices. At September 30, 2018, the Company has estimated
that it is probable that the performance conditions will be met. The awards were valued using a Monte Carlo valuation model using
a stock price at the date of grant of $9.60, a term of 3 to 5 years, a risk free interest rate of 1.6% to 2.1% and a volatility
factor of 66.5%. As of September 30, 2018, 186,600 shares from this set of awards have vested.
During
the three months ended September 30, 2018, the performance conditions of one of these restricted stock awards were met, resulting
in the full amortization of this award during the quarter. The number of restricted stock awards which vested was 133,333 and
the related compensation expense during the quarter was $573,686.
10.
Commitments and Contingencies
Leases
The
Company has entered into several non-cancellable operating leases for the rental of certain manufacturing and office space, equipment
and automobiles expiring in various years through 2021. The principal building lease provides for a monthly rental of approximately
$28,000.
Former
Chinese Distributor - FCPA
With
the assistance of outside counsel, the Company conducted a voluntary investigation into the business practices of the independent
Chinese entity that previously distributed its products in China and the Company’s knowledge of those business practices,
which may have implications under the FCPA, as well as into various internal controls issues identified during the investigation
(the “Investigation”).
On
September 27, 2016 and September 28, 2016, the Company voluntarily contacted the SEC and the DOJ, respectively, to advise both
agencies of these potential issues. The Company has provided and will continue to provide documents and other information to the
SEC and the DOJ, and is cooperating fully with these agencies in their ongoing investigations of these matters.
Although
the Company’s investigation is complete, additional issues or facts could arise which may expand the scope or severity of
the potential violations. The Company has no current information derived from the investigation or otherwise to suggest that its
previously reported financial statements and results are incorrect.
At
this stage, the Company is unable to predict what, if any, action the DOJ or the SEC may take or what, if any, penalties or remedial
measures these agencies may seek. Nor can the Company predict the impact on the Company as a result of these matters, which may
include the imposition of fines, civil and criminal penalties, which are not currently estimable, as well as equitable remedies,
including disgorgement of any profits earned from improper conduct and injunctive relief, limitations on the Company’s conduct,
and the imposition of a compliance monitor. The DOJ and the SEC periodically have based the amount of a penalty or disgorgement
in connection with an FCPA action, at least in part, on the amount of profits that a company obtained from the business in which
the violations of the FCPA occurred. During its distributorship relationship with the prior Chinese distributor from 2010 through
2016, the Company generated revenues of approximately $8 million.
Further,
the Company may suffer other civil penalties or adverse impacts, including lawsuits by private litigants in addition to the lawsuits
that already have been filed, or investigations and fines imposed by local authorities. The investigative costs to date are approximately
$3.1 million, of which approximately $0.1 million and $0.2 million was charged to general and administrative expenses during the
three months ended September 30, 2018 and 2017 respectively.
Former
Chinese Distributor – Litigation
On
April 5, 2017, the Company’s former distributor in China, Cicel (Beijing) Science & Technology Co., Ltd., filed a lawsuit
against the Company and certain officers and directors of the Company in the United States District Court for the Eastern District
of New York, alleging that the Company improperly terminated its contract with the former distributor. The complaint sought various
remedies, including compensatory and punitive damages, specific performance and preliminary and post judgment injunctive relief,
and asserted various causes of action, including breach of contract, unfair competition, tortious interference with contract,
fraudulent inducement, and conversion. On October 7, 2017, the court granted the Company’s motion to dismiss all of the
tort claims asserted against it, and also granted the individual defendants’ motion to dismiss all claims asserted against
them. The only claim currently remaining in the case is for breach of contract against the Company; the plaintiff has moved to
amend its complaint to add tort claims, which the Company has opposed. The Company believes it has various legal and factual defenses
to the allegations in the complaint, and intends to vigorously defend the action. The case is at its earliest stages; discovery
is just beginning and there is no trial date.
Stockholder
Derivative Litigation
On
June 6, 2017, Irving Feldbaum, an individual shareholder of Misonix, filed a lawsuit in the U.S. District Court for the Eastern
District of New York. The complaint alleges claims against the Company’s board of directors, its former CEO and CFO, certain
of its former directors, and the Company as a nominal defendant for alleged violations of Section 14(a) of the Securities Exchange
Act of 1934 and state law claims for breach of fiduciary duty, waste of corporate assets, and unjust enrichment. The complaint
alleges that the Company incurred damages as a result of alleged false and misleading statements in the Company’s securities
filings concerning the Company’s business, operations, and prospects and the Company’s internal control over financial
reporting. The complaint also alleges that the Company’s February 4, 2016 Proxy Statement contained false and misleading
statements regarding executive compensation. The complaint seeks the recovery of damages on behalf of the Company and the implementation
of changes to corporate governance procedures. On June 16, 2017, Michael Rubin, another individual shareholder of Misonix, filed
a case alleging similar claims in the same district court. On July 21, 2017, the district court consolidated the two actions for
all purposes. On July 16, 2018, the Company and counsel for Mr. Feldbaum and Mr. Rubin informed the District Court that the parties
had reached a settlement in principle. There are aspects of the settlement that remain to be negotiated and documented, and the
settlement is subject to approval by the District Court after notice to the Company’s shareholders.
11.
Related Party Transactions
OrthoXact
Proprietary Limited (“OrthoXact”) (formerly Applied BioSurgical) is an independent distributor for the Company in
South Africa. The chief executive officer of OrthoXact is also the brother of Stavros G. Vizirgianakis, the CEO of Misonix, Inc.
Set
forth below is a table showing the Company’s net revenues for the three months ended September 30 and accounts receivable
at September 30 for the indicated time periods below with OrthoXact:
|
|
For the three months ended
|
|
|
|
September 30,
|
|
|
|
2018
|
|
|
2017
|
|
|
|
|
|
|
|
|
Sales
|
|
$
|
296,881
|
|
|
$
|
169,340
|
|
Accounts receivable
|
|
$
|
236,478
|
|
|
$
|
154,475
|
|
12.
Income Taxes
For
the three months ended September 30, 2018 and 2017, the Company recorded income tax expense (benefit), as follows:
|
|
For the three months ended
|
|
|
|
September 30,
|
|
|
|
2018
|
|
|
2017
|
|
|
|
|
|
|
|
|
Income tax benefit
|
|
$
|
(427,000
|
)
|
|
$
|
(281,000
|
)
|
Valuation allowance on deferred tax asset
|
|
|
427,000
|
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
Net income tax benefit
|
|
$
|
—
|
|
|
$
|
(281,000
|
)
|
For
the three months ended September 30, 2018 and 2017, the effective rate of 0% and 18.8%, respectively, varied from the U.S. federal
statutory rate primarily due to the recording of a full valuation allowance on the remaining deferred tax assets, permanent book
tax differences relating principally to stock compensation expense and tax credits, and the impact of the Tax Cuts and Jobs Act
of 2017.
Tax
Cuts and Jobs Act of 2017
The
Tax Cuts and Jobs Act of 2017, enacted on December 22, 2017, contains significant changes to U.S. tax law, including lowering
the U.S. corporate income tax rate to 21%, implementing a territorial tax system, and imposing a one-time tax on deemed repatriated
earnings of foreign subsidiaries.
Valuation
Allowance on Deferred Tax Assets
Deferred
tax assets refer to assets that are attributable to differences between the financial statement carrying amounts of existing assets
and liabilities and their respective tax bases. Deferred tax assets in essence represent future savings of taxes that would otherwise
be paid in cash. The realization of the deferred tax assets is dependent upon the generation of sufficient future taxable income,
including capital gains. If it is determined that the deferred tax assets cannot be realized, a valuation allowance must be established,
with a corresponding charge to net income.
In
accordance with ASC Topic 740, the Company establishes valuation allowances for deferred tax assets that, in its judgment are
not more likely-than-not realizable. The guidance requires entities to evaluate all available positive and negative evidence,
including cumulative results in recent periods, weighted based on its objectivity, in determining whether its deferred tax assets
are more likely than not realizable.
The
Company regularly assesses its ability to realize its deferred tax assets. While the Company had positive cumulative pretax income
as of June 30, 2017, based on actual results for fiscal 2018 and the Company’s current forecast for fiscal 2019 the Company
is in a three-year cumulative loss position at September 30, 2018, and it expects to be in a cumulative pretax loss position as
of September 30, 2019. Management evaluated available positive evidence, including the continued growth of the Company’s
revenues and gross profit margins, its recent SonaStar technology license to its Chinese partner and the reduction in investigative
and professional fees recognized in fiscal 2017, along with available negative evidence, including the Company’s continuing
investment in building its next generation Nexus platform and its continuing investment in building a direct sales force, while
at the same time paying commissions to its domestic sales distributors. After weighing both the positive and negative evidence,
management concluded that the Company’s deferred tax assets are not more likely-than-not realizable. Accordingly, the Company
recorded a full valuation allowance against its deferred tax assets as of December 31, 2017 and has continued to record valuation
allowances against its deferred tax assets through September 30, 2018. The Company will continue to assess its ability to utilize
its net operating loss carryforwards, and will reverse this valuation allowance when sufficient evidence is achieved to allow
the realizability of such deferred tax assets.
As
of September 30, 2018 and June 30, 2018, the Company had no material unrecognized tax benefits or accrued interest and penalties.
13.
Segment Reporting
Operating
segments are defined as components of an enterprise about which separate financial information is available that is evaluated
on a regular basis by the chief operating decision-maker (“CODM”) in deciding how to allocate resources to an individual
segment and in assessing performance of the segment. The Company has concluded that its Chief Executive Officer is the CODM as
he is the ultimate decision maker for key operating decisions, determining the allocation of resources and assessing the financial
performance of the Company. These decisions, allocations and assessments are performed by the CODM using consolidated financial
information. Consolidated financial information is utilized by the CODM as the Company’s current product offering primarily
consists of minimally invasive therapeutic ultrasonic medical devices. The Company’s products are relatively consistent
and manufacturing is centralized and consistent across product offerings. Based on these factors, key operating decisions and
resource allocations are made by the CODM using consolidated financial data and as such the Company has concluded that it operates
as one segment.
Worldwide
revenue for the Company’s products and license revenue is categorized as follows:
|
|
|
For the three months ended
|
|
|
Net Change
|
|
|
|
|
September 30,
|
|
|
$
|
|
|
%
|
|
|
|
|
2018
|
|
|
2017
|
|
|
|
|
|
|
|
Domestic
|
|
|
$
|
5,404,518
|
|
|
$
|
4,727,342
|
|
|
$
|
677,176
|
|
|
|
14.3
|
%
|
International
|
|
|
|
3,956,646
|
|
|
|
2,553,381
|
|
|
|
1,403,265
|
|
|
|
55.0
|
%
|
Total
|
|
|
$
|
9,361,164
|
|
|
$
|
7,280,723
|
|
|
$
|
2,080,441
|
|
|
|
28.6
|
%
|
Substantially
all of the Company’s long-lived assets are located in the United States.