NOTES TO FINANCIAL STATEMENTS
(UNAUDITED)
1. Summary of Significant Accounting and Reporting Policies
Basis of Presentation
The accompanying unaudited
financial statements of Allied Healthcare Products, Inc. (the “Company”) have been prepared in accordance with the
instructions for Form 10-Q and do not include all of the information and disclosures required by accounting principles generally
accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments, consisting
only of normal recurring adjustments considered necessary for a fair presentation, have been included. Operating results for any
quarter are not necessarily indicative of the results for any other quarter or for the full year. These statements should be read
in conjunction with the financial statements and notes to the financial statements thereto included in the Company’s Annual
Report on Form 10-K for the year ended June 30, 2018.
Adoption of new revenue recognition standard
In May 2014, the Financial
Accounting Standards Board (FASB) issued a new accounting standard that amends the guidance for the recognition of revenue from
contracts with customers to transfer goods and services. The FASB subsequently issued additional, clarifying standards to address
issues arising from implementation of the new revenue recognition standard. The new revenue recognition standard and clarifying
standards require an entity to recognize revenue when control of promised goods or services is transferred to the customer at an
amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The
Company adopted this new standard as of July 1, 2018, by applying the modified-retrospective method to those contracts that were
not completed as of that date.
The results for reporting
periods beginning after July 1, 2018, are presented in accordance with the new standard, although comparative information has not
been restated and continues to be reported under the accounting standards and policies in effect for those periods. See Note 2,
Summary of Significant Accounting Policies, to the financial statements in our Annual Report on Form 10-K for the year ended June
30, 2018.
The cumulative impact on
accumulated deficit as a result of the adoption of this standard did not have a material impact on the Company’s historical
net losses and, therefore, no adjustment was made to the opening balance of accumulated deficit. In addition, the impact on reported
total revenues and operating income as compared to what reported amounts would have been under the prior standard was also immaterial.
The Company expects the impact of adoption in future periods to also be immaterial. The accounting policies under the new standard
were applied prospectively and are described below. See Note 2, Revenues.
Recently Issued Accounting Guidance
In February 2016, the FASB
issued ASU 2016-02, “Leases (Topic 842)” (“ASU 2016-02”), which requires lessees to recognize assets and
liabilities for leases with lease terms of more than 12 months and disclose key information about leasing arrangements. Consistent
with current U.S. GAAP, the recognition, measurement, and presentation of expenses and cash flows arising from a lease by a lessee
primarily will depend on its classification as a finance or operating lease. The update is effective for reporting periods beginning
after December 15, 2018. Early adoption is permitted. The Company is in the process of evaluating the impact of this update on
its financial statements.
Fair Value of Financial Instruments
The
Company’s financial instruments consist of cash and cash equivalents, accounts receivable, accounts payable and the
revolving credit facility. The carrying amounts for cash and cash equivalents, accounts receivable and accounts payable
approximate their fair value due to the short maturity of these instruments. The carrying amount of the revolving credit
facility approximates fair value due to the debt having a variable interest rate.
2. Revenues
The Company’s revenues
are derived primarily from the sales of respiratory products, medical gas equipment and emergency medical products. The products
are generally sold directly to distributors, customers affiliated with buying groups, individual customers and construction contractors,
throughout the world.
The Company recognizes
revenue from product sales upon the transfer of control, which is generally upon shipment or delivery, depending on the delivery
terms set forth in the customer contract. Payment terms between Allied and its customers vary by the type of customer, country
of sale, and the products offered. The term between invoicing and the payment due date is not significant.
Management exercises judgment
in estimating variable consideration. Provisions for early payment discounts, rebates and returns and other adjustments are provided
for in the period the related sales are recorded. Historical data is readily available and reliable, and is used for estimating
the amount of the reduction in gross sales.
The Company provides rebates
to wholesalers. Rebate amounts are based upon purchases using contractual amount for each product sold. Factors used in the rebate
calculations include the identification of which products have been sold subject to a rebate and the customer or price terms that
apply. Using known contractual allowances, the Company estimates the amount of the rebate that will be paid, and records the liability
as a reduction of gross sales when it records the sale of the product. Settlement of the rebate generally occurs in the month following
the sale.
The Company regularly analyzes
the historical rebate trends and makes adjustments to reserves for changes in trends and terms of rebate programs. Historically,
adjustments to prior years’ rebate accruals have not been material to net income.
Other allowances charged
against gross sales include cash discounts and returns, which are not significant. Cash discounts are known within 15 to 30 days
of sale, and therefore can be reliably estimated. Returns can be reliably estimated because the Company’s historical returns
are low, and because sales return terms and other sales terms have remained relatively unchanged for several periods. Product warranties
are also not significant.
The Company does not allocate transaction
price as the Company has only one performance obligation and its contracts do not span multiple periods.
The
Company operates in one segment consisting of the
manufacturing, marketing and distribution of a variety of respiratory
products used in the health care industry to hospitals, hospital equipment dealers, hospital construction contractors, home health
care dealers and emergency medical product dealers. The Company’s product lines include respiratory care products, medical
gas equipment and emergency medical products.
The Company does not have
any one single customer that represents more than 10 percent of total sales. Sales by region, and by product, are as follows:
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|
Sales by Region
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|
|
|
|
|
|
|
Three months ended
|
|
|
|
September 30,
|
|
|
|
2018
|
|
|
2017
|
|
|
|
|
|
|
|
|
Domestic United States
|
|
$
|
5,777,984
|
|
|
$
|
5,962,687
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|
Europe
|
|
|
113,156
|
|
|
|
126,961
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|
Canada
|
|
|
158,160
|
|
|
|
163,283
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|
Latin America
|
|
|
509,713
|
|
|
|
641,768
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|
Middle East
|
|
|
92,595
|
|
|
|
117,908
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|
Far East
|
|
|
615,867
|
|
|
|
883,149
|
|
Other International
|
|
|
1,422
|
|
|
|
1,097
|
|
|
|
$
|
7,268,897
|
|
|
$
|
7,896,853
|
|
|
|
Sales by Product
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|
|
|
|
|
|
|
|
|
|
Three months ended
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September 30,
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|
|
2018
|
|
|
2017
|
|
|
|
|
|
|
|
|
Respiratory care products
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|
$
|
2,076,304
|
|
|
$
|
2,053,357
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|
Medical gas equipment
|
|
|
3,672,592
|
|
|
|
4,220,397
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|
Emergency medical products
|
|
|
1,520,001
|
|
|
|
1,623,099
|
|
|
|
$
|
7,268,897
|
|
|
$
|
7,896,853
|
|
3. Inventories
Inventories are comprised as follows:
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September 30, 2018
|
|
|
June 30, 2018
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|
|
|
|
|
|
|
|
Work-in progress
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|
$
|
516,965
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|
|
$
|
388,252
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|
Component parts
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|
|
7,434,538
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|
|
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6,775,870
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Finished goods
|
|
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2,219,592
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|
|
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2,285,836
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|
Reserve for obsolete and excess inventories
|
|
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(1,619,417
|
)
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|
|
(1,619,417
|
)
|
|
|
$
|
8,551,678
|
|
|
$
|
7,830,541
|
|
4. Earnings per share
Basic earnings per share
are based on the weighted average number of shares of all common stock outstanding during the period. Diluted earnings per share
are based on the sum of the weighted average number of shares of common stock and common stock equivalents outstanding during the
period. The number of basic and diluted shares outstanding for the three months ended September 30, 2018 and 2017 were 4,013,537.
5. Commitments and Contingencies
Legal Claims
The Company is subject
to various investigations, claims and legal proceedings covering a wide range of matters that arise in the ordinary course of its
business activities. The Company intends to continue to conduct business in such a manner as to avert any FDA action seeking to
interrupt or suspend manufacturing or require any recall or modification of products.
The Company has recognized
the costs and associated liabilities only for those investigations, claims and legal proceedings for which, in its view, it is
probable that liabilities have been incurred and the related amounts are estimable. Based upon information currently available,
management believes that existing accrued liabilities are sufficient.
Stuyvesant Falls Power
Litigation
. The Company is currently involved in litigation with Niagara Mohawk Power Corporation d/b/a National Grid (“Niagara”),
which provides electrical power to the Company’s facility in Stuyvesant Falls, New York, and one other party. The Company
maintains in its defense of the lawsuit that it is entitled to a certain amount of free electricity based on covenants running
with the land which have been honored for more than a century. After the commencement of the litigation, Niagara began sending
invoices to the Company for electricity used at the Company’s Stuyvesant Falls plant. Niagara’s attempts to collect
such invoices were stopped in December 2010 by a temporary restraining order. Among other things, Niagara seeks as damages the
value of electricity received by the Company without charge. The total value of electricity at issue in the litigation is not known
with certainty and Niagara has alleged different amounts of damages. Niagara alleged in its Second Amended Verified Complaint,
dated February 6, 2012, damages of approximately $469,000 in free electricity from May 2003 through May 2010. Niagara also alleged
in its Motion For Summary Judgment, filed on March 14, 2014, damages of approximately $492,000 in free electricity from May 2010
through the date of the filing. In April 2015, Allied received an invoice for electrical power at the Stuyvesant Falls plant with
an “Amount Due” balance of $696,000 as of March 31, 2015 without any description as to the period of time covered by
the invoice.
The Company filed a Motion
for Summary Judgment on March 14, 2014, seeking dismissal of Niagara’s claims and oral arguments on the motions were held
on June 13, 2014. On October 1, 2014, the Court granted the Company’s motion, denied Niagara’s motion and ruled that
the Company is entitled to receive electrical power pursuant to the power covenants. On October 26 and October 30, 2014, Niagara
and the other party filed separate notices of appeal of the Court’s decision. On March 31, 2016 the Supreme Court of New
York, Appellate Division, Third Department reversed the trial court decision and held that the free power covenants are no longer
enforceable. The Company’s application for leave to appeal this ruling was dismissed as premature by the New York Court of
Appeals on September 20, 2016. On May 26, 2017 the Company again moved for leave to appeal the March 31, 2016 decision. That motion
was granted on October 7, 2017 by the New York State Court of Appeals. The Company filed its brief and record on January 26, 2018.
Niagara and the other party to the lawsuit, Albany Engineering Corporation, filed their responses on July 16, 2018 and the Company
filed its reply on August 14, 2018. The matter will next be scheduled for argument, most likely in 2019.
The appellate decision
terminated the enforceability of the free power covenants as of March 31, 2016. The appellate decision did not order the Company
to pay any amounts for power consumed prior to such date and the Company believes that it is not liable for any such damages as
a result of the appellate decision. On December 21, 2016, Niagara filed a motion to the trial court asking that it hold additional
proceedings to establish what damages, if any, are owed to Niagara as the result of the appellate decision. The Company filed its
response on January 23, 2017. On April 25, 2017, the court denied Niagara’s motion in its entirety finding that no damages
could be awarded based on the Appellate Division’s decision. Niagara has filed a Notice of Appeal from that decision, but
to date, has not filed the appeal.
As of September 30, 2018,
the Company has not recorded a provision for this matter. The Company commenced paying for power at the Stuyvesant Falls facility
in April 2016.
Employment Contract
The Company has entered
into an employment contract with its chief executive officer with annual renewals. The contract includes termination without cause
and change of control provisions, under which the chief executive officer is entitled to receive specified severance payments
generally equal to two times ending annual salary if the Company terminates his employment without cause or he voluntarily terminates
his employment with “good reason.” “Good Reason” generally includes changes in the scope of his duties
or location of employment but also includes (i) the Company’s written election not to renew the Employment Agreement and
(ii) certain voluntary resignations by the chief executive officer following a “Change of Control” as defined in the
Agreement.
6. Financing
The Company is party to
a Loan and Security Agreement with Summit Financial Resources, L.P. (“Summit”), dated effective February 27, 2017,
as amended April 16, 2018 (as amended, the “Credit Agreement”). Pursuant to the Credit Agreement, the Company obtained
a secured revolving credit facility (the “Credit Facility”). The Company’s obligations under the Credit Facility
are secured by all of the Company’s personal property, both tangible and intangible, pursuant to the terms and subject to
the conditions set forth in the Credit Agreement. Availability of funds under the Credit Agreement is based on the Company’s
accounts receivable and inventory but will not exceed $2,000,000. At September 30, 2018 availability under the agreement was
$1,622,040.
The Credit Facility will
be available, subject to its terms, on a revolving basis until it expires on February 27, 2020, at which time all amounts outstanding
under the Credit Facility will be due and payable. Advances will bear interest at a rate equal to 2.00% in excess of the prime
rate as reported in the Wall Street Journal. Interest is computed based on the actual number of days elapsed over a year of 360
days. In addition to interest, the Credit facility requires that the Company pay the lender a monthly administration fee in an
amount equal to forty-seven hundredths percent (0.47%) of the average outstanding daily principal amount of loan advances for the
each calendar month, or portion thereof.
Regardless of the amount
borrowed under the Credit Facility, the Company will pay a minimum amount of .25% (25 basis points) per month on the maximum availability
$(5,000 per month). In the event the Company prepays or terminates the Credit Facility prior to February 27, 2020, the Company
will be obligated to pay an amount equal to the minimum monthly payment multiplied by the number of months remaining between February
27, 2020 and the date of such prepayment or termination.
Under the Credit Agreement,
advances are generally subject to customary borrowing conditions and to Summit’s sole discretion to fund the advances. The
Credit Agreement also contains covenants with which the Company must comply during the term of the Credit Facility. Among other
things, such covenants require the Company to maintain insurance on the collateral, operate in the ordinary course and not engage
in a change of control, dissolve or wind up the Company.
The Credit Agreement also
contains certain events of default including, without limitation: the failure to make payments when due; the material breach of
representations or warranties contained in the Credit Agreement or other loan documents; cross-default with other indebtedness
of the Company; the entry of judgments or fines that may have a material adverse effect on the Company; failure to comply with
the observance or performance of covenants contained in the Credit Agreement or other loan documents; insolvency of the Company,
appointment of a receiver, commencement of bankruptcy or other insolvency proceedings; dissolution of the Company; the attachment
of any state or federal tax lien; attachment or levy upon or seizure of the Company’s property; or any change in the Company’s
condition that may have a material adverse effect. After an event of default, and upon the continuation thereof, the principal
amount of all loans made under the Credit Facility would bear interest at a rate per annum equal to 20.00% above the otherwise
applicable interest rate (provided, that the interest rate may not exceed the highest rate permissible under law), and Summit would
have the option to accelerate maturity and payment of the Company’s obligations under the Credit Facility.
At September 30, 2018,
the Company had $377,960 of indebtedness, including capital lease obligations, short-term debt and long term debt. The prime rate
as reported in the Wall Street Journal was 5.25% on September 30, 2018.
The Company was in compliance
with all of the covenants associated with the Credit Facility at September 30, 2018.
7. Income Taxes
The Company accounts for
income taxes under ASC Topic 740: “Income Taxes.” Under ASC 740, the deferred tax provision is determined using the
liability method, whereby deferred tax assets and liabilities are recognized based upon temporary differences between the financial
statement and income tax bases of assets and liabilities using presently enacted tax rates. Valuation allowances are established
when necessary to reduce deferred tax assets to the amounts expected to be realized. In the quarter ended September 30, 2018
the Company recorded the tax benefit of losses incurred during the current quarter in the amount of approximately $305,000.
As the realization of the tax benefit of the net operating loss is not assured an additional valuation allowance of approximately
$305,000 was recorded. In the quarter ended September 30, 2017 the Company recorded the tax benefit of losses incurred in
the amount of approximately $292,000. As the realization of the tax benefit of the net operating loss is not assured an additional
valuation allowance of approximately $292,000 was recorded. The total valuation allowance recorded by the Company as of September
30, 2018 and 2017 was approximately $2,505,000 and $2,845,000, respectively. The Tax Cuts and Jobs Act (“TCJA”) was
enacted in the U.S. on December 22, 2017. The TCJA reduces the U.S. federal corporate tax rate from 35% to 21%. As a result of
this reduction in rate in the second quarter of the fiscal year ended 2018 the Company recorded a reduction in its recognized deferred
tax assets along with a reduction in the valuation allowance. The impact of these adjustments resulted in a net reduction of recognized
deferred tax assets and a resultant income tax expense in the amount of $136,386. To the extent that the Company’s losses
continue in future quarters, the tax benefit of those losses will be subject to a valuation allowance.