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Memry 10-Q 2005 Table of ContentsUNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
Form 10-Q
(Mark One)
For the quarterly period ended September 30, 2005
OR
For the transition period from to
Commission file number: 001-15971
Memry Corporation (Exact name of registrant as specified in its charter)
(203) 739-1100 (Registrant’s telephone number, including area code)
N/A (Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ¨ No x
As of November 2, 2005, 28,755,390 shares of the registrant’s common stock, par value $.01 per share, were issued and outstanding.
Table of Contents
FORM 10-Q For the quarter ended September 30, 2005 INDEX
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Table of ContentsPART I — FINANCIAL INFORMATION ITEM 1. Condensed Consolidated Financial Statements
Memry Corporation and Subsidiaries Condensed Consolidated Balance Sheets (Unaudited)
See Notes to Condensed Consolidated Financial Statements.
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Table of ContentsMemry Corporation and Subsidiaries Condensed Consolidated Statements of Income For the Three Months Ended September 30, 2005 and 2004 (Unaudited)
See Notes to Condensed Consolidated Financial Statements.
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Table of ContentsMemry Corporation and Subsidiaries Condensed Consolidated Statements of Cash Flows For the Three Months Ended September 30, 2005 and 2004 (Unaudited)
See Notes to Condensed Consolidated Financial Statements.
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Table of ContentsMEMRY CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Note A. BASIS OF PRESENTATION
Memry Corporation (the “Company”), a Delaware corporation incorporated in 1981, is engaged in the business of developing, manufacturing and marketing products and components that are sold primarily to the medical device industry. The Company utilizes shape memory alloys and extruded polymers in the production of most of its products.
The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three month period ended September 30, 2005, are not necessarily indicative of the results that may be expected for the year ending June 30, 2006 (“fiscal 2006”). For further information, refer to the consolidated financial statements and footnotes thereto included in the Annual Report on Form 10-K/A for the year ended June 30, 2005 (“fiscal 2005”). On July 1, 2005, the Company adopted Statement of Financial Accounting Standards (“SFAS”) No. 123(R), “Share-Based Payment,” which is a revision of SFAS No. 123, “Accounting for Stock-Based Compensation.” See Note B for a description of the effects on the consolidated financial statements. In the first quarter of fiscal 2006, there have been no other material changes to the significant accounting policies.
The results of operations of Putnam Plastics Company LLC (“Putnam Plastics Company”) have been included in the consolidated statements of income from the November 9, 2004 date of acquisition of substantially all of the assets and assumed selected liabilities of Putnam Plastics Corporation (the “Putnam Acquisition”). The term “Putnam” is used herein to refer to the business operated by Putnam Plastic Corporation prior to the Putnam Acquisition and Putnam Plastics Company thereafter. See Note I.
Note B. STOCK-BASED EMPLOYEE COMPENSATION
Stock-based Compensation Plans
During the year ended June 30, 1994, the Company adopted the Memry Corporation Stock Option Plan (the “1994 Plan”). Under the 1994 Plan, incentive stock options were granted at prices equal to or greater than the fair market value of the Company’s common stock at the date of grant, and were exercisable at the date of grant unless otherwise stated. In addition, non-qualified stock options were granted at prices determined by the Company’s compensation committee, which may have been less than the fair market value of the Company’s common stock at the date of grant, in which case an expense equal to the difference between the stock option exercise price and fair market value was recognized. The exercise period for both the incentive and non-qualified stock options generally could not exceed ten years. The 1994 Plan expired on September 23, 2003. No additional stock options may be granted from the 1994 Plan after this date.
During the year ended June 30, 1998, the Company adopted the Memry Corporation Long-term Incentive Plan (the “1997 Plan”). Under the 1997 Plan, 6,000,000 incentive and non-qualified stock options may be granted to employees and non-employee directors under terms similar to the 1994 Plan. Also, under the 1997 Plan, Stock Appreciation Rights (“SARs”), Limited Stock Appreciation Rights (“Limited SARs”), restricted stock, and performance shares may be granted to employees. With respect to SARs, upon exercise, the Company must pay to the employee the difference between the current market value of the Company’s common stock and the exercise price of the SARs. The SARs terms are determined at the time of each individual grant. However, if SARs are granted which are related to an incentive stock option, then the SARs will contain similar terms to the related option. Limited SARs may be granted in relation to any option or SARs granted. Upon exercise, the Company must pay to the employee the difference between the current market value of the Company’s common stock and the exercise price of the related options or SARs. Upon the exercise of SARs or Limited SARs, any related stock option or SARs outstanding will no longer be exercisable. As of June 30, 2005 and 2004, there were no SARs or Limited SARs outstanding.
During the first quarter of fiscal year 2006, the Company began granting performance-based options (“PBOs”) under the 1997 Plan. Under the PBO feature, each fiscal year the Company may grant selected executives and other key employees share option awards whose vesting is contingent on meeting various company-wide performance goals based primarily on revenue growth and profitability over a multi-year period. The fair value of each PBO granted is estimated on the date of the grant using the same option valuation model used for options previously granted under the 1997 Plan and assuming performance
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Table of Contentsgoals will be achieved. If any of such goals are met, a percentage of said options shall vest in accordance with the prescribed vesting schedule. If such goals are not met, no compensation cost is recognized and any recognized compensation cost is reversed relating to the specific goal and vesting period.
Restricted shares of common stock may also be granted to employees for no consideration. The terms of the restriction are determined at the time of each individual grant. Generally, if employment is terminated during the restriction period, the participant must forfeit any common stock still subject to restriction. Performance shares are granted to employees based on individual performance goals, and may be paid in shares or cash determined based on the shares earned and the market value of the Company’s common stock at the end of certain defined periods. No performance or restricted shares have been issued to employees.
Also under the 1997 Plan, each quarter, all non-employee directors were to be granted shares of the Company’s common stock with a value equal to $7,500, determined based on the market value of the Company’s stock at the end of each quarter. During the year ended June 30, 2002, this policy was amended such that all non-employee directors, each quarter, are granted shares of the Company’s common stock with a value equal to $3,000 and stock options with a value equal to $4,500, determined based on the closing market value of the Company’s stock as of the date of the approval by the Compensation Committee of the Board of Directors. The stock options granted to non-employee directors are non-qualified options.
Adoption of SFAS No. 123(R)
On July 1, 2005, the Company adopted SFAS No. 123(R), which is a revision of SFAS No. 123. SFAS No. 123(R) establishes standards for the accounting for transactions where an entity exchanges its equity for goods or services and the transactions that are based on the fair value of entity’s equity instruments or that may be settled by the issuance of those equity instruments. SFAS No. 123(R) focuses primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions and, in effect, accounts for those transactions as part of the consolidated financial statements of the entity and not as a footnote disclosure, as the Company had elected under the provisions of SFAS No. 123. Under SFAS No. 123(R), the Company is required to record compensation expense for all awards granted after the date of adoption and for the unvested portion of previously granted stock awards that remain outstanding as of the date of adoption. The Company recorded compensation expense of $171,000 related to the adoption of SFAS No. 123(R) for the first quarter of fiscal 2006. To date, the majority of the Company’s stock option grants have been qualified incentive stock options (“ISOs”). ISO’s are nondeductible for income tax purposes therefore, an income tax benefit has only been recorded for compensation expense on non-qualified options calculated under the provisions of SFAS No. 123(R). For the first quarter of fiscal 2006, compensation expense of $19,000 ($12,000 net of income taxes) was recorded on non-qualified options.
Pro-Forma Disclosures
In adopting SFAS No. 123(R), the Company elected not to use the modified retrospective application and, therefore did not restate its results for the three months ended September 30, 2004. During this period, the Company was following SFAS No. 123, which allowed an entity to continue to measure compensation cost for those plans using the intrinsic value based method of accounting prescribed by Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees,” whereby compensation cost is the excess, if any, of the quoted market price of the stock at the grant date (or other measurement date) over the amount an employee must pay to acquire the stock. Stock options issued to employees and directors under the Company’s stock option and warrant plans have no intrinsic value at the grant date, and under Opinion No. 25 no compensation cost was recognized. Under APB Opinion No. 25, the Company generally only recorded stock-based compensation expense for the fair value of common stock issued to its directors which was $20,000 ($12,000 net of income taxes) and $21,000 ($13,000 net of income taxes) for the first quarters of fiscal 2006 and fiscal 2005, respectively.
On January 1, 2003, the Company adopted SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure, an Amendment of SFAS No. 123.” For the first quarter of fiscal 2005, the Company has elected to continue with the accounting methodology in APB Opinion No. 25 and, as a result, has provided pro forma disclosures of net income and earnings per share, and other disclosures, as if the fair value based method of accounting had been applied. Had compensation cost for issuance of such stock options and warrants been recognized based on the fair values of awards on the grant dates, in accordance with the method described in SFAS No. 123(R) for the first quarter of fiscal 2005, reported net income and per share amounts for the first quarters of fiscal 2006 and 2005, respectively, would have been as follows. The reported and pro forma net income and per share amounts for the first quarter of fiscal 2006 are the same since stock-based compensation is calculated under the provisions of SFAS No. 123(R). The amounts from the first quarter of fiscal 2006 are included in the following table only to provide the detail for comparative presentation to the first quarter of fiscal 2005.
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Table of Contents
Determining Fair Value
The fair value of each grant is estimated on the grant date using a Black-Scholes option valuation model based on the assumptions in the following table. The weighted average expected lives (estimated period of time outstanding) was estimated using the simplified method for determining the expected term. Expected volatility was based on the historical volatility for a period equal to the stock option’s expected life.
Note C. INVENTORIES
Inventories consist of the following at September 30, 2005 and June 30, 2005:
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Table of ContentsNote D. ACCOUNTS PAYABLE AND ACCRUED EXPENSES
Accounts payable and accrued expenses consist of the following at September 30, 2005 and June 30, 2005:
Note E. EARNINGS PER SHARE
Basic earnings per share amounts are computed by dividing net income by the weighted-average number of common shares outstanding. Diluted per share amounts assume exercise of all potential common stock instruments unless the effect is antidilutive.
The following is information about the computation of weighted-average shares utilized in the computation of basic and diluted earnings per share.
Note F. INCOME TAXES
A reconciliation of the income tax provision computed by applying the statutory Federal income tax rate of 34% to income before income taxes as reported in the condensed consolidated statements of income follows. The nondeductible expense for stock-based compensation on ISOs in the first quarter of fiscal 2006 was $152,000.
As of June 30, 2005, the Company had net operating loss carryforwards of approximately $9,500,000 available to reduce future Federal taxable income, which expire in 2008 through 2011.
Note G. NOTE RECEIVABLE
On August 24, 2004, the Company entered into a joint development program (the “Agreement”) with Biomer Technology Limited (“Biomer”), a privately-owned company specializing in the development and manufacture of state-of-the-art
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Table of Contentspolymers and biocompatible coatings for stents and other medical devices. Under the terms of the Agreement, the Company made a $400,000 initial investment in Biomer in the form of a 2% unsecured convertible promissory note (the “Note”). Interest on the Note is payable upon conversion, or upon repayment of the Note. As of September 30, 2005, the Company has accrued $9,000 in interest income that has been added to the note receivable. Under the terms of the Note, the Note plus accrued interest will be converted into ordinary shares of Biomer stock upon the occurrence of the earlier of, as defined, the successful completion of the joint development program, an additional equity financing of Biomer, the sale of Biomer, or December 31, 2005. On October 5, 2005, Biomer completed an equity financing which triggered conversion of the Note into 37,860 ordinary shares of Biomer stock. The Company’s initial investment and accrued interest of $409,000 was recorded as a note receivable as of September 30, 2005. That amount, plus any additional accrued interest, was converted to an investment as of October 5, 2005 which, since the Company will not have a controlling ownership interest or significant influence over Biomer’s financial reporting or operations, will be accounted for on the cost basis.
The Agreement requires the Company to make an additional equity investment of at least $350,000 in Biomer in the event, as defined, a financing of Biomer occurs after the Note has been converted and successful completion of the joint development program has been accomplished. Additionally, as part of the joint development program and in consideration for services provided by Biomer in the joint development program, the Company agreed to pay Biomer $200,000 in four equal quarterly installments of $50,000 beginning August 24, 2004. As of September 30, 2005, three installments have been paid totaling $150,000. An additional $50,000 payment has been accrued as of September 30, 2005 until specific milestones that indicate completion of the joint development program, as specified in the Agreement, are met. The $200,000 was amortized over the initial one year term of the joint development program.
Note H. INTANGIBLE ASSETS
The following table sets forth intangible assets, including the accumulated amortization as of June 30, 2005 and September 30, 2005:
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Table of ContentsIntangible assets are amortized on a straight-line basis over their expected useful lives. Amortization expense related to intangible assets was $168,000 and $33,000 for the three months ended September 30, 2005 and 2004, respectively. Amortization expense is expected to be $671,000 for the year ended June 30, 2006. Of these amounts, $42,000 was charged for the three months ended September 30, 2005 and $167,000 is expected to be charged for the year ended June 30, 2006 to cost of revenues. Estimated annual amortization expense of intangible assets for the next five years is expected to be as follows:
YEAR ENDING JUNE 30,
Note I. ACQUISITION
On November 9, 2004, the Company completed the Putnam Acquisition. Putnam is one of the nation’s leading, specialty polymer-extrusion companies serving the medical device, laser, fiber-optic, automotive and industrial markets. Its primary products are complex, multi-lumen, multi-layer extrusions used for guide wires, catheter shafts, delivery systems and various other interventional medical procedures. Putnam’s products are known for their complex configurations, multiple material construction and innovative designs. Putnam also is well known for its ability to manufacture to tight tolerances.
The purchase price, including acquisition costs, consisted of $18.9 million in cash (of which $400,000, see Note D, has been accrued as of September 30, 2005), 2,857,143 shares of the Company’s common stock (with a fair value of $4.6 million) and $2.5 million in deferred payments (with a fair value of $2.2 million). The shares are subject to various restrictions, including a black out period, which prohibits the sale of the shares for a period of 18 months after November 9, 2004. Additionally, after the expiration of the black out period, subject to certain exceptions, the sale of shares in the public market is limited to 250,000 per calendar quarter.
The purchase price of the Putnam Acquisition has been allocated to the assets acquired and liabilities assumed based on their respective fair values. The Company has allocated the purchase price as follows:
The consolidated financial statements for the three months ended September 30, 2005 include the results of operations of Putnam. The following table discloses the reported consolidated results for the three months ended September 30, 2005 and the pro forma consolidated results for the three months ended September 30, 2004 assuming the Putnam Acquisition was made at the beginning of fiscal 2005:
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Table of ContentsThe pro forma consolidated results for the three months ended September 30, 2004 do not purport to be indicative of results that would have occurred had the Putnam Acquisition been in effect for the period presented.
Note J. COMMON STOCK
The Company has included in a preliminary proxy statement dated October 28, 2005, a proposal to its shareholders to approve the increase in the number of authorized shares of $.01 par value common stock from 40,000,000 to 60,000,000 shares.
Note K. SUBSEQUENT EVENT
On November 9, 2005, Webster Business Credit Corporation, the Company’s principal lender, permanently waived the Company’s cash collateral deposit requirements. As of September 30, 2005 and June 30, 2005, this deposit was $1,500,000.
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
References to the “Company,” “we,” “our” and “us” refer to Memry Corporation and its subsidairies, unless otherwise noted.
RECENT DEVELOPMENTS
On October 5, 2005, Biomer completed an equity financing which triggered conversion of the receivable into 37,860 ordinary shares of Biomer stock. The Company’s initial investment and accrued interest of $409,000 was recorded as a note receivable as of September 30, 2005. That amount, plus any additional accrued interest, was converted to an investment as of October 5, 2005 which, since the Company will not have a controlling ownership interest or significant influence over financial reporting or operations, will be accounted for on the cost basis.
On November 9, 2005, Webster Business Credit Corporation, the Company’s principal lender, permanently waived the Company’s cash collateral deposit requirements. As of September 30, 2005 and June 30, 2005, this deposit was $1,500,000. See (b) “LIQUIDITY AND CAPITAL RESOURCES” for more information.
ACCOUNTING POLICIES AND CRITICAL ACCOUNTING ESTIMATES
We have adopted various accounting policies to prepare the condensed consolidated financial statements in accordance with accounting principles generally accepted in the United States of America.
For our accounting policies that, among others, are critical to the understanding of our results of operations due to the assumptions we make in their application, refer to Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, in our Annual Report on Form 10-K/A for the year ended June 30, 2005. Senior management has discussed the development and selection of these accounting policies, and estimates, and the related disclosures with the Audit Committee of the Board of Directors. See Note 1 of the Notes to the Consolidated Financial Statements in our Annual Report on Form 10-K /A for the year ended June 30, 2005 for our significant accounting policies. On July 1, 2005, the Company adopted SFAS No. 123(R), “Share-Based Payment,” which is a revision to SFAS No. 123, “Accounting for Stock-Based Compensation.” See Note B for a description of the effects on the consolidated financial statements. In the first quarter of fiscal 2006, there have been no other material changes to the significant accounting policies.
The preparation of the consolidated financial statements, in conformity with accounting principles generally accepted in the U.S. 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 accounts receivable, inventories, goodwill, intangible assets, income taxes and contingencies and litigation, 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:
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Table of ContentsAccounts Receivable. We provide allowances for doubtful accounts on our accounts receivable for estimated losses resulting from the inability of our customers to make required payments. If the financial condition of our customers were to deteriorate, which may result in the impairment of their ability to make payments, additional allowances may be required. On a regular basis, we review and evaluate the customers’ financial condition, which generally includes a review of the customers’ financial statements, trade references and past payment history with us. We specifically evaluate identified customer risks that may be present and collateral requirements, if any, from the customer, which may include, among other things, deposits, prepayments or letters of credit.
Inventories. We state our inventories at the lower of cost or market. We maintain inventory levels based on our projections of future demand and market conditions. Any sudden decline in demand or technological change can cause us to have excess or obsolete inventories. On an ongoing basis, we review for estimated obsolete or unmarketable inventories and write-down our inventories to their estimated net realizable value based upon our forecasts of future demand and market conditions. These write-downs are reflected in cost of goods sold. If actual market conditions are less favorable than our forecasts, additional inventory write-downs may be required. Our estimates are primarily influenced by a sudden decline in demand due to economic downturn and technological changes.
Goodwill and Intangible Assets. Goodwill represents the excess of the aggregate purchase price over the fair value of net assets of acquired businesses. Goodwill is tested for impairment annually, or more frequently if changes in circumstance or the occurrence of events suggest an impairment exists. The test for impairment requires us to make several estimates about fair value. Goodwill was $13,946,000 as of September 30, 2005 and June 30, 2005.
Intangible assets consist primarily of management’s estimates of patents, developed technology, customer relationships, trade name, and other intangible assets that have been identified as a result of the Company’s purchase accounting for past acquisitions. These assets are being amortized over their useful life, determined to be 4.5 to 20 years, depending on the nature of the asset and the asset class. We review intangible assets for impairment annually or as changes in circumstance or the occurrence of events suggest the remaining value is not recoverable. Intangible assets, net of accumulated amortization, were $7,674,000 and $7,842,000 as of September 30, 2005 and June 30, 2005, respectively. This decrease is due to amortization expense of $168,000 for the three months ended September 30, 2005.
Income Taxes. Deferred taxes are provided on a liability method whereby deferred tax assets are recognized for deductible temporary differences and operating loss and tax credit carryforwards and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities and their tax bases. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. The recognition of a valuation allowance for deferred taxes requires management to make estimates about the Company’s future profitability. The estimates associated with the valuation of deferred taxes are considered critical due to the amount of deferred taxes recorded on the consolidated balance sheet and the judgment required in determining the Company’s future profitability. Deferred tax assets were $4,544,000 and $4,899,000 as of September 30, 2005 and June 30, 2005, respectively.
Contingencies and Litigation. We are currently involved in certain legal proceedings and, as required, have accrued estimates of probable costs for the resolution of these claims. These estimates have been developed in consultation with outside counsel and are based upon an analysis of potential results, assuming a combination of litigation and settlement strategies. It is possible, however, that future results of operations for any particular quarterly or annual period could be materially affected by changes in our assumptions or the effectiveness of our strategies related to these proceedings.
The following is management’s discussion and analysis of certain significant factors that have affected the Company’s financial position and results of operations. Certain statements under this caption may constitute “forward-looking statements.” See Part II — “Other Information.”
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Table of Contents(a) RESULTS OF OPERATIONS
The following tables compare net sales by product line for the three months ended September 30, 2005 and 2004, respectively.
The following table sets forth the Company’s condensed consolidated statements of income for the three months ended September 30, 2005 and 2004, respectively.
Three Months Ended September 30, 2005, compared to Three Months Ended September 30, 2004.
Introduction
In the past several years, the Company has focused on increasing the amount of value-added products it provides to the marketplace, i.e., products where additional processing is performed on basic nitinol wire, strip, or tube before it is shipped to the customer. Currently, medical device applications represent some of the best opportunities for increasing the amount of value-added business. The kink-resistant and self-expanding properties of nitinol have made peripheral stenting an area of special interest, and stent components manufactured for Abdominal Aortic Aneurysms (AAA) in particular have become a significant driver of the Company’s revenues. However, because the market for stent components is very dynamic and rapidly changing, the Company has found it difficult to accurately forecast demand for its stent components. Delays in product launches, uncertain timing on regulatory approvals, inventory adjustments by our customers, market share shifts between competing stent platforms, issues in supply and manufacturing and the introduction of next-generation products have all contributed to the variability in revenue generated by shipments of medical stent components.
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Table of ContentsOn November 9, 2004, the Company completed the Putnam Acquisition. Putnam utilizes polymer extrusion technology to produce polymer-based products sold primarily to the medical device industry. The largest current application for Putnam’s technology is for catheters. Putnam also utilizes its extrusion capabilities for guide wires, delivery systems, and various other interventional medical devices. As in the nitinol portion of the Company, Putnam is focusing on growing the value-added segment of its business by performing additional processing on its semi-finished polymer tube. The large majority of Putnam’s products are sold directly to the medical device industry through the Memry direct sales organization. The results of operations of Putnam have been included in the consolidated results of operations from the date of acquisition.
Revenues. Revenues increased 39% to $12,677,000 in the first quarter of fiscal 2006 from $9,112,000 during the same period in fiscal 2005, an increase of $3,555,000. The increase in revenues was due principally to the inclusion of revenues generated by Putnam. Putnam’s revenue for the first quarter of fiscal 2006 was $3,453,000.
Other increases in nitinol products from the first quarter of fiscal 2006 compared to the first fiscal quarter of fiscal 2005 included shipments of components utilized in general surgical applications of approximately $750,000 and nitinol tube-based stent components of approximately $150,000. In addition. revenues from prototype development and research and development activities increased approximately $125,000 (excluding Putnam’s revenues for similar activities of approximately $375,000), shipments of high pressure sealing plugs increased $100,000 and the Company recorded higher shipments of microcoil and guidewire products, which increased approximately $75,000 for the first quarter of fiscal 2006 compared with the similar period in fiscal 2005.
Substantially offsetting these increases were decreased shipments of nitinol wire-based stent components, sold to the Company’s largest customer, which declined approximately $300,000. This decrease was caused primarily by shortages in acceptable raw material from one of the Company’s suppliers related to this product line. Looking forward to the remainder of fiscal 2006, the Company anticipates that overall nitinol stent component revenues for fiscal 2006 will experience some decline from the revenues in fiscal 2005.
Additionally, revenue decreases of approximately $575,000 in super elastic tube resulting primarily from a combination of customer inventory adjustments, price discounts and loss of market share, arch wire products of approximately $250,000 and tinel lock of approximately $25,000 were recorded for the three months ended September 30, 2005 compared to the three months ended September 30, 2004.
Costs and Expenses. Manufacturing costs increased $2,306,000 or 41% to $7,918,000 in the first quarter of fiscal 2006 from $5,612,000 in the first quarter of fiscal 2005. The increase was due primarily to the inclusion of Putnam, which recorded cost of revenues of $1,921,000. The comparable operations of the Company from the first quarter of fiscal 2006 to the first quarter of fiscal 2005 operated at a lower gross margin primarily due to a shift in the product mix of shipments toward those products with higher per unit direct production costs, especially in general surgical applications and prototype development and research and development activities. The Company experienced price pressure on several product lines, and during the quarter we also incurred additional expense associated with the launch of a new guidewire product. In addition, stock-based compensation of $30,000 was charged to cost of revenues for the first quarter of fiscal 2006 due to the adoption of SFAS No. 123(R).
As a result of these factors, the Company’s gross profit decreased from 38.4% in the first quarter of fiscal 2005 to 37.5% in the first quarter of fiscal 2006. The Company’s ability to maintain or grow its gross profit margin is dependent on several factors. One is the product mix of the Company’s shipments, which can be effected by customer requirements, capacity of specific product lines and general timing. Another is the success of the Company in securing sufficient business to absorb plant overhead, particularly high margin nitinol tube business. The Company has begun to invest in the manufacturing operations at Putnam, including staff, equipment, and systems to grow Putnam’s revenues over the next several years. These investments are expected to continue for the foreseeable future and may have the effect of reducing profitability, particularly in the short-term, at Putnam.
Operating expenses, including research and development costs, general, selling and administration expenses and amortization of intangible assets increased $1,199,000, or 51%, to $3,572,000 in the first quarter of fiscal 2006, compared to $2,373,000 in the first quarter of fiscal 2005. Total operating expenses as a percentage of revenues increased from 26% in the first quarter of fiscal 2005 to 28% in the first quarter of fiscal 2006 primarily as a result of the addition of administration and sales and marketing personnel and programs associated with the Putnam Acquisition, amortization of intangible assets of $93,000 related to Putnam and marketing program initiatives undertaken in the first quarter of fiscal 2006. Further cost increases were also driven by the Company adopting SFAS No. 123(R) in the first quarter of fiscal 2006 and the related stock-based compensation of $141,000, the continuing increase in administration costs related to investor relations, legal and accounting activities, higher personnel costs and increased consultants’ fees in conjunction with the Sarbanes-Oxley Act of 2002 Section 404 implementation efforts.
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Table of ContentsNet interest expense was $278,000 in the first quarter of fiscal 2006 compared to net interest income of $26,000 in the first quarter of fiscal 2005. The change from period to period was due principally to an increase in interest expense, including the amortization of deferred financing costs of $24,000, associated with a higher level of borrowings utilized to finance a portion of the Putnam Acquisition, and higher overall borrowing costs due to an increase in LIBOR from the first quarter fiscal 2005 to the first quarter fiscal 2006.
Income Taxes. The Company recorded a provision for income taxes of $398,000 for the first quarter of fiscal 2006, compared to a provision of $450,000 for the first quarter of fiscal 2005. The decrease in the provision is the result of a decrease in the income before income taxes offset by the exclusion of the deduction for the recording of the stock-based compensation in the first quarter of fiscal 2006. This had the effect of increasing the income tax provision by $57,000, which was the primary reason for the effective tax rate increase of 5% from the first quarter of fiscal 2005 to fiscal 2006. As a result, the effective tax rate was 44% and 39% for the first quarters of fiscal 2006 and 2005, respectively.
Net Income. As a result of the factors discussed above, the Company’s net income decreased by $202,000, to $501,000 in the first quarter of fiscal 2006 compared to $703,000 for the same period in fiscal 2005.
(b) LIQUIDITY AND CAPITAL RESOURCES
At September 30, 2005, the Company’s cash and cash equivalents balance was $3,634,000, a decrease of $507,000 from $4,141,000 at the start of fiscal 2006. Net cash provided by operations was $653,000 for the three months ended September 30, 2005, an increase of $335,000 from $318,000 provided during the same three-month period ended September 30, 2004. This increase was due principally to an increase in cash collections of accounts receivable of $357,000, an increase in cash generated by net income and adjustments to reconcile net income to net cash provided by operating activities of $271,000, offset by decreases in accounts payable and accrued expenses of $214,000 and increases in net cash used for inventories of $127,000.
Net cash used in investing activities increased $308,000 to $1,053,000 for the three months ended September 30, 2005 compared to $745,000 during the same three-month period ended September 30, 2004. This increase was due to an increase in cash used for capital expenditures of $913,000 primarily the purchases of previously leased and new lasers for cutting nitinol tube at the Company’s Menlo Park, California facility of $661,000 and a scanning electron microscope in the Bethel, Connecticut facility of $276,000. This increase is partially offset by an investment in Biomer of $400,000 in the form of a 2% unsecured convertible promissory note and $210,000 of payments related to the Putnam Acquisition in the first quarter of fiscal 2005.
During the three months ended September 30, 2005, net cash used in financing activities was $107,000, reflecting the pay-down of the note payable to Webster Business Credit Corporation of $305,000 offset by the proceeds from the issuance of common stock of $198,000. Working capital at September 30, 2005 was $8,782,000, an increase of $440,000 from $8,342,000 at June 30, 2005. The increase in working capital is a result of net income and non-cash expenses such as depreciation and amortization, deferred income taxes, equity based compensation and accreted interest on notes payable exceeding capital expenditures and principal payments on notes payable for the first quarter of fiscal 2006.
In fiscal 2005, the primary capital requirements were to fund the Putnam Acquisition, capital expenditures and the Biomer Note. In the three months ended September 30, 2005, the primary capital requirement was to fund capital expenditures and principal payments on notes payable.
In connection with the Putnam Acquisition on November 9, 2004, the Company entered into a credit and security agreement with Webster Business Credit Corporation (the “Webster Agreement”) which replaced the existing credit facility with Webster Bank. The Webster Agreement includes a term loan facility consisting of a five-year term loan of $1.9 million (the “Five Year Term”) and a three-year term loan of $2.5 million (the “Three Year Term” together with the Five Year Term known as the “Term Loan Facility”). Both term loans are repayable in equal monthly installments with the additional requirement that, under the Three Year Term, a prepayment of 50% of excess cash flow, as defined, be made annually within 90 days of the Company’s fiscal year end. The excess cash flow prepayment requirement was waived by Webster Business Credit Corporation for fiscal 2005, but remains in effect for the remaining years of the loan term. Interest under the Five Year Term is based upon, at the Company’s option, LIBOR plus 2.75% or the alternate base rate, as defined, plus 0.25%. Interest under the Three Year Term is based upon, at the Company’s option, LIBOR plus 3.75% or the alternate base rate, as defined, plus 1.25%. Borrowings under the Term Loan Facility were used to repay approximately $1.4 million in outstanding borrowings under the existing facility with Webster Bank and to partially fund the Putnam Acquisition.
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Table of ContentsThe Webster Agreement also provides for a revolving line of credit for borrowings up to the lesser of (a) $6,500,000 or (b) an amount equal to the aggregate of (1) 85% of the eligible accounts receivable plus (2) the lesser of $3,000,000 or 55% of eligible inventories. Interest under the revolving line of credit is based upon, at the Company’s option, LIBOR plus 2.50% or the alternate base rate, as defined. The entire outstanding principal amount of the revolving line of credit is due November 9, 2009. As of September 30, 2005, there were no amounts outstanding under the revolving line of credit. Additionally, the Webster Agreement includes an equipment line of credit that provides for equipment financing up to the lesser of $1,000,000 or 80% of the hard cost for eligible equipment through November 9, 2005 at the same financing terms as the Five Year Term. Any outstanding amount under the equipment line as of November 9, 2005 will convert to a term loan payable monthly based on a seven year amortization schedule, but with a balloon payment of the then unpaid balance due November 9, 2009. Borrowings under the Webster Agreement are collateralized by substantially all of the Company’s assets.
The Webster Agreement contains various restrictive covenants, including, among others, the limitation of mergers, acquisitions and joint ventures, limitations on encumbrances and additional debt, limitations on the payment of dividends or redemption of stock and compliance a fixed charge coverage ratio and leverage ratio, as defined. Additionally, the Company was required to maintain cash as collateral security until the Three Year Term loan was paid in full. For the first year of the Webster Agreement, the collateral deposit requirement was $1,500,000. This amount has been classified as cash collateral deposits on the consolidated balance sheet as of September 30, 2005. On November 9, 2005, Webster Business Credit Corporation permanently waived the Company’s cash collateral deposit requirements, and these funds will be accounted for as cash and cash equivalents as of October 25, 2005.
Additional financing for the Putnam Acquisition was obtained on November 9, 2004 from Brookside Pecks Capital Partners, L.P. and Ironbridge Mezzanine Fund, L.P. in the form of a $7.0 million subordinated loan due November 9, 2010 (the “Subordinated Loan”). The interest rate on the Subordinated Loan is 16.5%, of which 12% is payable quarterly with the remaining 4.5% payable in additional promissory notes having identical terms as to the Subordinated Loan. Originally, the interest rate was 17.5% with 5.5% payable in additional promissory notes, but was reduced because the Company achieved certain pretax income thresholds in fiscal 2005. In future years, the interest rate is subject to similar reductions by reaching similar pretax thresholds and subject to increase in the event of default.
The Subordinated Loan contains various restrictive covenants including, among others, the limitation of mergers, acquisitions and joint ventures, limitations on encumbrances and additional debt, limitations on the payment of dividends or redemption of stock and compliance with a fixed charge coverage ratio and leverage ratio, as defined. The Note payable outstanding under the Subordinated Loan as of September 30, 2005 and June 30, 2005 was $4,803,000 and $4,752,000, respectively.
The remaining financing for the Putnam Acquisition was provided for with the Company’s cash on hand and $2.5 million in deferred payments. The deferred payments are non-interest bearing and are required to be paid to the seller in three equal annual installments. The first of these installments of $833,000 was paid on November 9, 2005 and is included, less $15,000 of non-cash interest expense accrued during the period from October 1, 2005 to November 9, 2005, in current maturities of notes payable as of September 30, 2005. Total obligations of $2,346,000 and $2,313,000 were outstanding for the non-interest bearing deferred payments as of September 30, 2005 and June 30, 2005, respectively.
On August 24, 2004, the Company entered into the Agreement with Biomer. Under the terms of the Agreement, the Company made a $400,000 initial investment in Biomer in the form of a 2% unsecured convertible promissory note (the “Note”). Interest on the Note is payable upon conversion, or upon repayment of the Note. As of September 30, 2005, the Company has accrued $9,000 in interest income that has been added to the note receivable. Under the terms of the Note, the Note plus accrued interest will be converted into ordinary shares of Biomer stock upon the occurrence of the earlier of, as defined, the successful completion of the joint development program, an additional equity financing of Biomer, the sale of Biomer, or December 31, 2005. On October 5, 2005, Biomer completed an equity financing which triggered conversion of the Note into 37,860 ordinary shares of Biomer stock. The Company’s initial investment and accrued interest of $409,000 was recorded as a note receivable as of September 30, 2005. That amount, plus any additional accrued interest, will be converted to an investment as of October 5, 2005 which, since the Company will not have a controlling ownership interest or significant influence over Biomer’s financial reporting or operations, will be accounted for on the cost basis.
The Agreement requires the Company to make an additional equity investment of at least $350,000 in Biomer in the event, as defined, a financing of Biomer occurs after the Note has been converted and successful completion of the joint development program has been accomplished. Additionally, as part of the joint development program and in consideration for services provided by Biomer in the joint development program, the Company agreed to pay Biomer $200,000 in four equal quarterly installments of $50,000 beginning August 24, 2004. As of September 30, 2005, three installments have been
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Table of Contentspaid totaling $150,000. An additional $50,000 payment has been accrued as of September 30, 2005 until specific milestones that indicate completion of the joint development program, as specified in the Agreement, are met. The $200,000 was amortized over the initial one year term of the joint development program.
The Company has requirements to fund plant and equipment projects to support the expected increased sales volume of shape memory alloys and extruded-polymer products during the fiscal 2006 and beyond. The Company expects that it will be able to finance these expenditures through a combination of existing working capital cash flows generated through operations and increased borrowings (including equipment financing). The largest risk to the liquidity of the Company would be an event that caused an interruption of cash flow generated through operations, because such an event could also have a negative impact on the Company’s ability to access credit. The Company’s current dependence on a limited number of products and customers represents the greatest risk to operations.
The Company has in the past grown through acquisitions (including the Putnam Acquisition, Wire Solutions, Inc. and Raychem Corporation’s nickel titanium product line). As part of its continuing growth strategy, the Company expects to continue to evaluate and pursue opportunities to acquire other companies, assets and product lines that either complement or expand the Company’s existing businesses. The Company intends to use available cash from operations, debt, and authorized but unissued common stock to finance any such acquisitions.
In December 2004, the Company signed a lease for one of its manufacturing facilities located in Menlo Park, CA , expanding its usage of the building from 10,000 to 22,000 square feet. The term of the lease began on December 1, 2004 and expires on June 30, 2008. The monthly base rent is $18,000.
In November 2004, the Company signed a lease for Putnam’s manufacturing facility located in Dayville, Connecticut. The lessor is Mr. James V. Dandeneau, the sole shareholder of Putnam Plastics Corporation, and currently a director and executive officer of the Company. The term of the lease runs from November 10, 2004 until November 30, 2009 with renewal options to extend the lease for two terms of 32 months. The monthly rent is $18,000.
Off-Balance Sheet Arrangements
The Company does not maintain any off-balance sheet arrangements, transactions, obligations or other relationships with unconsolidated entities that would be expected to have a material current or future effect upon the Company’s financial condition or results of operations.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
There has been no material change to the Company’s disclosure on this matter made in the Company’s Annual Report on Form 10-K/A for the year ended June 30, 2005.
ITEM 4. CONTROLS AND PROCEDURES
(a) Evaluation of disclosure controls and procedures.
We carried out an evaluation, under the supervision and with the participation of our management including our president and chief executive officer and chief financial officer, of the effectiveness of our disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) as of the end of the period covered by this report. Based on this evaluation, our president and chief executive officer and chief financial officer have concluded that our disclosure controls and procedures are effective as of the end of the period covered by this report.
(b) Changes in internal control over financial reporting.
There was no change in our internal control over financial reporting that occurred during the first quarter of fiscal 2006 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
PART II — OTHER INFORMATION
Certain statements in this Quarterly Report on Form 10-Q that are not historical fact, as well as certain information incorporated herein by reference, constitute “forward-looking statements” made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements involve risks and uncertainties and often depend on assumptions, data or methods that may be incorrect or imprecise. The Company’s future operating results may differ materially from the results discussed in, or implied by, forward-looking statements made by the Company. Factors that may cause such differences include, but are not limited to, those discussed below and the other risks detailed in the Company’s other reports filed with the Securities and Exchange Commission.
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Table of ContentsForward-looking statements give our current expectations or forecasts of future events. You can usually identify these statements by the fact that they do not relate strictly to historical or current facts. They often use words such as “anticipate”, “estimate,” “expect,” “project,” “intend,” “plan,” “believe,” and other words and terms of similar meaning in connection with any discussion of future operating or financial performance. In particular, these include statements relating to future actions, prospective products or product approvals, future performance or results of current and anticipated products, sales efforts, expenses, the outcome of contingencies such as legal proceedings, and financial results.
Any or all of our forward-looking statements in this Quarterly Report on Form 10-Q and information incorporated by reference may turn out to be wrong. They can be affected by inaccurate assumptions we might make or by known or unknown risks and uncertainties. Many factors mentioned in this discussion—for example, product competition and the competitive environment—will be important in determining future results. Consequently, no forward-looking statement can be guaranteed. Actual future results may vary materially. The Company undertakes no obligation to revise any of these forward-looking statements to reflect events or circumstances after the date hereof.
Other Factors That May Affect Future Results
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ITEM 6. EXHIBITS
(a) EXHIBITS
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Table of ContentsSIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
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