Gross
profit as a percentage of net sales decreased to 25 and 41 percent,
respectively, for the three and nine-month periods ended March 31, 2014 from 50
percent and 51 percent, respectively, for the three and nine-month periods
ended March 31, 2013. The gross margin rate for the three and nine-month
periods ended March 31, 2014 was impacted by 22 percentage points and 7
percentage points, respectively, as a result of the $739,000 Prostiva capital equipment
write-down mentioned above. The remaining decrease in gross profit as a
percentage of sales is due to higher manufacturing costs per unit due to lower
production volumes and higher Prostiva material costs.
Sales and Marketing
Sales
and marketing expense of $1.3 million for the third quarter of fiscal year 2014
decreased by $602,000, or 31 percent, when compared to sales and marketing
expense of $1.9 million in the same period of fiscal 2014. The decrease in
sales and marketing expense for the three-months ended March 31, 2014 is due to
a $361,000 decrease in headcount related expenses due to decreased commissions
and decreased headcount as a result of the restructuring plan implemented in
January 2014. In addition, travel expenses decreased by $83,000 due to lower
headcount, advertising and promotions decreased by $71,000, and meeting
expenses decreased by $35,000. These decreases were partially offset by
approximately $17,000 of expense related to the restructuring previously
mentioned.
Sales
and marketing expense of $4.8 million for the nine-month period ended March 31,
2014 decreased $800,000, or 14 percent, when compared to sales and marketing
expense of $5.6 million in the same period of fiscal 2013. The decrease in
sales and marketing expense year-over-year is largely due to decreased wage and
benefit and travel related expenses of $446,000 due to decreased headcount,
partially as a result of the restructuring plan implemented in January 2014. In
addition, marketing expenses decreased by $202,000 and meeting expenses
decreased by $90,000.
General and
Administrative
General
and administrative expense decreased $184,000, or 26 percent, to $527,000 for
the three-month period ended March 31, 2014 compared to $711,000 for the
three-month period ended March 31, 2013. The decrease in general and
administrative expense is a result of decreased spending in all general and
administrative areas in an effort to manage expenses. In particular, wages and
benefits decreased $83,000 due to lower headcount, and public reporting fees
decreased $29,000 as a result of our Nasdaq delisting and no longer needing to
pay the related listing fees.
For
the nine-months ended March 31, 2014, general and administrative expense decreased
$321,000 or 15 percent to $1.8 million from $2.1 million for the nine-month
period ended March 31, 2013. The decrease in general and administrative expense
is again a result of a decrease in wages and benefits of $254,000 due to lower
headcount, a $68,000 decrease in public reporting and investor relation fees,
and a $30,000 decrease in stock option expense, partially offset by an increase
in consulting fees of $60,000.
Research and
Development
Research
and development expense, which includes expenditures for product development,
regulatory compliance and clinical studies, decreased $130,000 or 24 percent to
$408,000 for the three-month period ended March 31, 2014 from $538,000 for the
three-month period ended March 31, 2013. The decrease in research and
development expense is a result of a $90,000 decrease in expense for the
monthly transition services fee related to the Prostiva license agreement which
was paid in the prior year period. These fees ended when we became the legal
manufacturer of Prostiva in April 2013. The remaining decrease is related to
decreases in wages and benefits of $47,000 due to lower headcount in the
current year.
For
the nine-months ended March 31, 2014, research and development expense
decreased $475,000, or 27 percent, to $1.3 million from $1.8 million for the
nine-month period ended March 31, 2013. The decrease in research and
development expense year-over-year is a result of a $270,000 decrease in
expense for the monthly transition services fee related to the Prostiva license
agreement mentioned above, as well as decreases in consulting expenses.
Change in Value of
Acquisition Consideration
The
change in the value of acquisition consideration was $12,000 and $105,000,
respectively, for the three and nine-month periods ended March 31, 2014,
compared to zero and $369,000 for the three and nine- month periods ended March
31, 2013, respectively. For the three and nine-month periods ended March 31,
2014, the change in the value of acquisition consideration represents the
reduction in fair value of contingent consideration of $12,000 and $105,000,
respectively, as a result of a reduction in the projected royalty payments in
excess of contractual minimums in earlier years. For the nine-month period ended
March 31, 2013, the change in the value of acquisition consideration represents
the net effect of a reduction in fair value of contingent consideration of
$791,000, partially offset by an increase of $422,000 in non-contingent
consideration. These changes were due to an increase in the projected time it
would take the Company to reach the cumulative $10 million of royalty and
license fees owed on the Prostiva acquisition, which increased the number of
years subject to minimum royalty payments and reduced the projected royalty
payments in excess of contractual minimums in earlier years.
18
Gain on
Demutualization
The
gain on demutualization of $321,000 for the three and nine-month periods ended
March 31, 2013 represents the gain resulting from the demutualization of our
products liability insurance carrier. This event did not repeat in the current
fiscal year period.
Medical Device Tax
The
medical device tax expense represents the excise tax imposed beginning January
1, 2013 on all U.S. medical device sales as part of the Federal health care
reform legislation. The medical device excise tax expense of $52,000 for the
three-month period ended March 31, 2014, increased by $11,000 or 27 percent,
when compared to medical device excise tax expense of $41,000 for the
three-months ended March 31, 2013. The increase in the medical device tax
expense is due to the fact that we did not become the legal manufacturer of the
Prostiva product line until April 2013, and therefore did not pay excise tax on
these sales in the prior year period. Medical device excise tax expense of
$172,000 for the nine-month period ended March 31, 2014, increased by $131,000
or 320 percent due to the fact that the medical device tax was not implemented
until January, 2013 and therefore only represents 3 months of expenses versus 9
months of expense in the current year period.
Amortization of
Identifiable Intangible Assets
Amortization
of identifiable intangible assets was $28,000 and $26,000 for the three-month
period ended March 31, 2014 and 2013, respectively. Amortization of
identifiable intangible assets was $72,000 and $78,000 for the nine-month
period ended March 31, 2014 and 2013, respectively. The slight increase in
amortization expense of the three-month period ended March 31, 2014 is due to
the write-off of capitalized patents. The slight decrease in amortization
expense for the nine-month period ended March 31, 2014 is a result of the
$160,000 impairment charge related to intangible assets acquired as part of the
Prostiva acquisition in the fourth quarter of fiscal 2013 which resulted in
lower amortization expense over the assets remaining useful lives.
Net Interest Expense
Interest
expense is a result of non-cash interest accretion on the deferred acquisition
payments for the Prostiva business as well as the interest expense accrued on
the Note entered into with Medtronic on June 28, 2013. Interest expense
increased to $178,000 from $98,000 for the three-months ended March 31, 2014
and 2013, respectively. For the nine-months ended March 31, 2014, interest
expense increased $168,000 to $516,000 from $348,000 for the nine-months ended
March 31, 2013. The increase in interest expense is due to accrued interest on
the Medtronic Note signed at the end of fiscal year 2013, partially offset by
lower accretion expense related to the restructuring of the license agreement
with Medtronic which resulted in the re-measurement of the contingent
consideration.
Provision for Income
Taxes
We
recognized income tax expense of $18,000 and $46,000 for the three and
nine-months ended March 31, 2014, respectively, compared to income tax expense
of $17,000 and $48,000 for the three and nine-month periods ended March 31,
2013, respectively. The tax expense in the three and nine-months ended March
31, 2014 consists of $9,000 and $27,000, respectively, of deferred tax expense
recorded on the amortization for tax purposes of indefinite-lived goodwill
intangibles acquired in the Prostiva acquisition, as well as $9,000 and
$19,000, respectively, for state taxes. The tax expense in the three and
nine-month periods ended March 31, 2013 also relates to the deferred tax
liability resulting from the amortization for tax purposes of the goodwill
acquired in the Prostiva acquisition, as well as provisions for state taxes.
The
Company utilizes the asset and liability method of accounting for income taxes.
The Company recognizes deferred tax liabilities or assets for the expected
future tax consequences of temporary differences between the book and tax basis
of assets and liabilities. We have recorded and continue to carry a full
valuation allowance against our gross deferred tax assets that will not reverse
against deferred tax liabilities. We will continue to assess the assumptions
used to determine the amount of our valuation allowance and may adjust the
valuation allowance in future periods based on changes in assumptions of
estimated future income and other factors.
19
LIQUIDITY AND CAPITAL RESOURCES
We
have financed our operations since inception through sales of equity
securities, including a follow-on offering completed during the first quarter
of fiscal year 2013 and, to a lesser extent, sales of our Cooled ThermoTherapy
products and, beginning September 6, 2011, sales of the Prostiva RF Therapy
System product. As of March 31, 2014, our cash balance was $816,000.
During
the first quarter of fiscal 2012, the Company entered into a license agreement
with Medtronic for the Prostiva RF Therapy System. The Company paid Medtronic
$500,000 on September 6, 2011 for half of the $1,000,000 initial license fee,
with the remaining $500,000 payable on September 6, 2012. On June 28, 2013, we
entered into a Restructuring Agreement with Medtronic related to the $7.5
million we owed to Medtronic under the Transaction Documents. As part of this
agreement we paid Medtronic $2.0 million in satisfaction of royalties earned
for the 12 months ended September 6, 2012, the second half of the initial licensing
fee, the license maintenance fee for the 12 month period ended September 6,
2012, for outstanding transition services fees, and for Prostiva inventory
included as part of the acquisition and purchased subsequent to the
acquisition. In addition, we entered into a promissory note (the Note) with
Medtronic for $5.3 million for the remaining amounts owed on Prostiva inventory
acquired as part of the acquisition and purchased subsequent to the
acquisition. Interest on the Note accrues at a rate of 6 percent, compounded
annually and is payable in five equal installments of principal, plus accrued
interest, on March 31
st
of each year beginning on March 31, 2015.
The $206,000 difference between the $7.5 million in obligations owed to
Medtronic and the $2.0 million paid and the $5.3 million Note was recorded as a
gain on debt extinguishment in fiscal year 2013. The Company does not have
adequate cash to repay the full outstanding principal amount of $5.3 million on
the Note. Any event of default under the Note may result in a loss of control
of our business or bankruptcy.
Under
the license agreement, royalty payments for Prostiva products are paid one year
in arrears based on the contract year. The royalty payment due during the
second quarter of fiscal year 2014 of $650,000 has not been paid as of March
31, 2014 or as of the date of filing this Quarterly Report on Form 10-Q. The
$650,000 is included in the short-term deferred acquisition payment liability
as of March 31, 2014. In addition, we did not pay, as of March 31, 2014 and as
of the date of filing this Quarterly Report on Form 10-Q, the annual $65,000
licensing maintenance fee due on September 6, 2013 which is included in other
accrued expenses as of March 31, 2014. The non-payment does not entitle
Medtronic to terminate the license agreement unless Medtronic provides written
notice and an opportunity to cure the default. The non-payment under the
license agreement is also not an event of default under the Note unless
Medtronic provides written notice and an opportunity to cure. In the event of a
material breach of the licensing agreement or other transaction documents, and
Medtronic provides written notice to the Company and the Company fails to cure
the breach, Medtronic may terminate the license agreement. If the license
agreement is terminated, the Companys rights to sell the Prostiva product
would be terminated.
On
January 11, 2012, the Company entered into a Loan and Security Agreement with
Silicon Valley Bank, as subsequently amended. The line of credit with Silicon
Valley Bank allows borrowing by the Company of up to the lesser of $2.0 million
or the defined borrowing base consisting of 80% of eligible accounts
receivable.
The
Company will not be able to draw down our line of credit with Silicon Valley
Bank upon a material breach of the license agreement or event of default under
the Note with Medtronic, or, as of January 30, 2014, payment to Medtronic of
any royalty payment or annual license payment or certain other actions by
Medtronic with respect to these payments. The terms of the agreement with
Silicon Valley bank state that any default with a third party, the result of
which could have a material adverse affect on our business, is considered an
event of default under the line of credit agreement and as of January 30, 2014,
that it is an event of default if the Company makes any royalty payment and/or
annual license payment to Medtronic, if Medtronic threatens to take action
against the Company to collect any portion of these payments, or if Medtronic
commences any action or proceeding against the Company with respect to these
payments. The Company may cure this event of default by receipt within 30 days
of its occurrence of net proceeds from a new round of equity or subordinated
debt financing of at least $715,000.
In
addition, in accordance with a letter agreement between the Company and
Medtronic dated March 21, 2014, the Company will not draw down any funds under
its line of credit with Silicon Valley Bank without prior approval from
Medtronic. The line of credit expires by its terms on June 30, 2014. As of
March 31, 2014 the Company has not borrowed against this facility.
During
the first quarter of fiscal year 2013 the Company completed a follow-on
offering which contributed approximately $3.8 million of net proceeds. However,
as a result of the Companys history of operating losses and negative cash
flows from operations there is substantial doubt about our ability to continue
as a going concern. As of March 31, 2014, the Companys cash may not be
sufficient to sustain day-to-day operations for the next 12 months.
The
Companys ability to continue as a going concern is dependent upon our ability
to generate positive cash flows from our business, maintain available borrowing
under our line of credit with Silicon Valley Bank, and aggressively manage our
expenses, including those associated with our acquisition of the Prostiva
product line from Medtronic. The Companys ability to continue as a going
concern is also dependent upon avoiding an event of default under the Note and
avoiding termination of the license relating to the Prostiva product, whether
by negotiation with Medtronic, cure of any non-payment giving rise to an event
of default or termination, or otherwise. There is no assurance that our cash,
cash generated from operations, if any, and available borrowing under our
agreement with Silicon Valley Bank will be sufficient to fund our anticipated
capital needs, operating expenses (including payments under the license
agreement), and Note repayments, particularly if product sales do not generate
revenues in the amounts currently anticipated, if our operating costs are
greater than anticipated or greater than our business can support.
20
If
the Company is unable to generate sufficient liquidity to meet its needs and in
a timely manner, the Company may be required to further reduce expenses and
curtail capital expenditures, sell assets, or suspend or discontinue
operations.
There
can be no assurance that the Company will be able to cure any potential event
of default of the Note or cure any breach of any agreement with Medtronic,
maintain compliance with its agreements with Medtronic, access available
borrowings under the line of credit with SVB, raise additional capital, or
improve its operating or financial performance.
The
third quarter fiscal year 2014 financial statements do not include any
adjustments to reflect the possible future effects on the recoverability and
classification of assets or the amounts and classifications of liabilities that
may result should the Company be unable to continue as a going concern.
During
the nine-months ended March 31, 2014, we used $1.4 million of cash for operating
activities. The net loss of $4.1 million included non-cash charges of $739,000
from the Prostiva inventory reserve, $447,000 from depreciation and
amortization expense, $169,000 from stock-based compensation expense and
$334,000 of accreted interest expense. Changes in operating items resulted in
the generation of $1.0 million of operating cash flow for the period as a
result of higher accounts payable of $387,000, lower inventories of $336,000,
lower accounts receivable of $342,000 and interest payable of $245,000. These
changes were partially offset by lower accrued expenses and deferred income of
$187,000 and higher prepaids and other assets of $86,000.
The
increase in accounts payable is the result of the timing of receipts and services
versus payment. The decrease in inventories is due to lower volumes of Prostiva
hand piece inventory as of March 31, 2014 due to the timing of shipments from
our third-party supplier, and the decrease in accounts receivable is due to a
decrease in revenue. The increase in interest payable represents the 6 percent
interest accrued on the Note agreement entered into with Medtronic in June,
2013. The decrease in accrued expenses and deferred income is a result of a
decrease in the commission accrual due to lower sales and lower headcount, as
well as a decrease in the bonus accrual as a result of the payment of the
fiscal 2013 bonuses during the first quarter of fiscal year 2014. The increase
in prepaids and other assets is a result of the payment of annual insurance
policies at the beginning of the fiscal year which are then amortized over the
annual period.
During
the nine-months ended March 31, 2014, we used $35,000 for investing activities
related to the purchase of property and equipment and investments in
intellectual property.
During
the nine-months ended March 31, 2014, we did not generate any cash from
financing activities.
We
plan to continue offering customers a variety of programs for both evaluation
and longer-term use of our Cooled ThermoTherapy system control units and
Prostiva RF Therapy System generators and scopes in addition to purchase
options. We also will continue to provide physicians and patients with
efficient access to our Cooled ThermoTherapy system control units and Prostiva
RF Therapy System generators and scopes on a pre-scheduled basis through our
mobile service. As of March 31, 2014, our property and equipment, net, included
approximately $319,000 of control units, generators and scopes used in evaluation
or longer-term use programs and units used in our Company-owned mobile service.
Off Balance Sheet Arrangements
We
do not have any off balance sheet arrangements.
Recently Issued Accounting Standards
Information
regarding recently issued accounting pronouncements is included in Note 15 to
the condensed financial statements in this Quarterly Report on Form 10-Q.