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Synergetics USA 10-Q 2011

Documents found in this filing:

  1. 10-Q
  2. Ex-31.1
  3. Ex-31.2
  4. Ex-32.1
  5. Ex-32.2
  6. Ex-32.2
form10q.htm


UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q

(Mark One)
 
R
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended April 30, 2011

 
£
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE TRANSITION PERIOD FROM _______________ TO _______________

Commission file number 001-10382

SYNERGETICS USA, INC.
(Exact name of registrant as specified in its charter)
 
Delaware
 
20-5715943
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
     
3845 Corporate Centre Drive
   
O’Fallon, Missouri
 
63368
(Address of principal executive offices)
 
(Zip Code)
         
 
(636) 939-5100
 
 
(Registrant’s Telephone Number, Including Area Code)
 

Indicate by check mark whether 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 R No £

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes £ No £

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.  (Check one):
 
Large Accelerated Filer
£
Accelerated Filer
£
Non-Accelerated Filer
£
Smaller Reporting Company
R
(Do not check if smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes £ No R

The number of shares outstanding of the issuer’s common stock, $0.001 value per share, as of June 2, 2011 was 24,965,704 shares.
 


 
 

 

SYNERGETICS USA, INC.
Index to Form 10-Q

     
Page
PART I
Financial Information
3
       
 
Item 1.
3
    3
      4
      5
      6
 
Item 2.
14
 
Item 3.
30
 
Item 4.
30
       
PART II
Other Information
31
       
 
Item 1.
31
 
Item 1A.
31
 
Item 2.
31
 
Item 3.
31
 
Item 4.
31
 
Item 5.
31
 
Item 6.
31
32
     
  33
     
Certification of Chief Executive Officer Pursuant to Section 302 of Sarbanes-Oxley Act of 2002
 
Certification of Chief Financial Officer Pursuant to Section 302 of Sarbanes-Oxley Act of 2002
 
Certification of Chief Executive Officer Pursuant to Section 906 of Sarbanes-Oxley Act of 2002
 
Certification of Chief Financial Officer Pursuant to Section 906 of Sarbanes-Oxley Act of 2002
 

 
2

 
Part I — Financial Information
Item 1 — Unaudited Condensed Consolidated Financial Statements
Synergetics USA, Inc. and Subsidiaries
Condensed Consolidated Balance Sheets>
As of April 30, 2011 (Unaudited) and July 31, 2010
(Dollars in thousands, except share data)

   
April 30,
2011
   
July 31,
2010
 
Assets
           
Current Assets
           
Cash and cash equivalents
  $ 16,991     $ 18,669  
Accounts receivable, net of allowance for doubtful accounts of $310 and $282, respectively
    9,361       9,056  
Inventories
    13,523       11,891  
Prepaid expenses
    1,156       792  
Deferred income taxes
    739       658  
Total current assets
    41,770       41,066  
Property and equipment, net
    8,686       8,044  
Intangible and other assets
               
Goodwill
    10,690       10,690  
Other intangible assets, net
    11,922       12,353  
Patents, net
    1,041       870  
Cash value of life insurance
    72       72  
Total assets
  $ 74,181     $ 73,095  
Liabilities and stockholders’ equity
               
Current Liabilities
               
Current maturities of long-term debt
  $ 1,206     $ 1,398  
Current maturities of revenue bonds payable
    --       116  
Accounts payable
    1,686       1,800  
Accrued expenses
    2,289       2,624  
Income taxes payable
    43       11  
Deferred revenue
    982       400  
Total current liabilities
    6,206       6,349  
Long-Term Liabilities
               
Long-term debt, less current maturities
    --       939  
Revenue bonds payable, less current maturities
    --       1,612  
Deferred revenue
    18,061       18,630  
Deferred income taxes
    1,287       1,339  
Total long-term liabilities
    19,348       22,520  
Total liabilities
    25,554       28,869  
Commitments and contingencies (Note 8)
               
Stockholders’ Equity
               
Common stock at April 30, 2011 and July 31, 2010, $0.001 par value, 50,000,000 shares authorized; 24,969,508 and 24,772,155 shares issued and outstanding, respectively
    25       25  
Additional paid-in capital
    25,492       24,905  
Retained earnings
    22,915       19,319  
Accumulated other comprehensive income (loss):
               
Foreign currency translation adjustment
    195       (23 )
Total stockholders’ equity
    48,627       44,226  
Total liabilities and stockholders’ equity
  $ 74,181     $ 73,095  

See Notes to Unaudited Condensed Consolidated Financial Statements.

 
3


Synergetics USA, Inc. and Subsidiaries
Consolidated Statements of Income
Three and Nine Months Ended April 30, 2011 and 2010
(Dollars in thousands, except share and per share data)

   
Three Months Ended
April 30, 2011
   
Three Months Ended
April 30, 2010
   
Nine Months Ended
April 30, 2011
   
Nine Months Ended
April 30, 2010
 
Net sales
  $ 14,695     $ 13,859     $ 40,049     $ 39,020  
Cost of sales
    6,148       5,828       16,746       16,647  
Gross profit
    8,547       8,031       23,303       22,373  
Operating expenses
                               
Research and development
    882       886       2,587       2,320  
Sales and marketing
    2,771       2,896       8,528       9,200  
General and administrative
    2,427       2,204       6,854       6,286  
      6,080       5,986       17,969       17,806  
Operating income
    2,467       2,045       5,334       4,567  
Other income (expenses)
                               
Investment income
    22       --       82       2  
Interest expense
    (37 )     (113 )     (182 )     (412 )
Settlement gain
    --       2,398       --       2,398  
Gain (Loss) on  sale of product line
    --       893       (99 )     817  
Miscellaneous
    --       (5 )     (11 )     23  
      (15 )     3,173       (210 )     2,828  
Income before provision for income taxes
    2,452       5,218       5,124       7,395  
Provision for income taxes
    809       1,909       1,528       2,667  
Net income
  $ 1,643     $ 3,309     $ 3,596     $ 4,728  
Earnings per share:
                               
Basic
  $ 0.07     $ 0.13     $ 0.14     $ 0.19  
Diluted
  $ 0.07     $ 0.13     $ 0.14     $ 0.19  
Basic weighted average common shares outstanding
    24,945,707       24,701,260       24,878,768       24,579,928  
Diluted weighted average common shares outstanding
    25,108,582       24,740,304       25,004,258       24,614,869  

See Notes to Unaudited Condensed Consolidated Financial Statements.

 
4


Synergetics USA, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
Nine Months Ended April 30, 2011 and 2010
(Dollars in thousands)

   
Nine Months Ended
April 30, 2011
   
Nine Months Ended
April 30, 2010
 
Cash Flows from Operating Activities
           
Net income
  $ 3,596     $ 4,728  
Adjustments to reconcile net income to net cash provided by operating activities
               
Depreciation
    822       784  
Amortization
    490       667  
Provision for doubtful accounts receivable
    15       (65 )
Stock-based compensation
    252       218  
Deferred income taxes
    (134 )     (435 )
Loss (gain) on sale of property and equipment
    50       (15 )
Loss (gain) on sale of product line
    99       (817 )
Changes in assets and liabilities
               
(Increase) decrease in:
               
Accounts receivable
    (279 )     (1,963 )
Inventories
    (1,564 )     1,388  
Prepaid expenses
    (337 )     (194 )
(Decrease) increase in:
               
Accounts payable
    (135 )     27  
Accrued expenses
    (346 )     (979 )
Income taxes payable
    32       1,618  
Deferred revenue
    13       19,030  
Net cash provided by operating activities
    2,574       23,992  
Cash Flows from Investing Activities
               
Proceeds from the sale of equipment
    11       15  
Purchase of property and equipment
    (1,525 )     (594 )
Acquisition of patents and other intangibles
    (231 )     (146 )
Proceeds from sale of product line
    --       1,336  
Net cash used in (provided by) investing activities
    (1,745 )     611  
Cash Flows from Financing Activities
               
Excess of outstanding checks over bank balance
    --       (75 )
Net (repayments) on lines-of-credit
    --       (5,035 )
Principal payments on revenue bonds payable
    (1,728 )     (1,620 )
Principal payments on long-term debt
    (686 )     (175 )
Payment on debt incurred for acquisition of trademark
    (445 )     (420 )
Tax benefit associated with the exercise of non-qualified stock options
    125       --  
Proceeds from the issuance of common stock
    211       12  
Net cash used in financing activities
    (2,523 )     (7,313 )
Foreign exchange rate effect on cash and cash equivalents
    16       8  
Net (decrease) increase in cash and cash equivalents
    (1,678 )     17,298  
Cash and cash equivalents
               
Beginning
    18,669       160  
Ending
  $  16,991     $ 17,458  

See Notes to Unaudited Condensed Consolidated Financial Statements.

 
5


Synergetics USA, Inc. and Subsidiaries
Notes to Unaudited Condensed Consolidated Financial Statements
 (Tabular information reflects dollars in thousands, except share and per share information)

Note 1. General>

Nature of business: Synergetics USA, Inc. (“Synergetics USA” or the “Company”) is a Delaware corporation incorporated on June 2, 2005, as a result of the reverse merger of Synergetics, Inc. (“Synergetics”) and Valley Forge Scientific Corp. (“Valley Forge”) and the subsequent reincorporation of Valley Forge (the predecessor to Synergetics USA) in Delaware. Synergetics USA is a medical device company.  Through continuous improvement and development of our people, our mission> is to design, manufacture and market innovative microsurgical devices, capital equipment, accessories and disposables of the highest quality in order to enable surgeons who perform microsurgery around the world to provide a better quality of life for their patients.   The Company’s primary focus is on the microsurgical disciplines of ophthalmology and neurosurgery. Our distribution channels include a combination of direct and independent sales organizations and important strategic alliances with market leaders. The Company is located in O’Fallon, Missouri and King of Prussia, Pennsylvania.  During the ordinary course of its business, the Company grants unsecured credit to its domestic and international customers.

Basis of presentation: The unaudited condensed consolidated financial statements include the accounts of Synergetics USA, Inc., and its wholly owned subsidiaries: Synergetics, Synergetics Development Company, LLC, Synergetics Delaware, Inc. and Synergetics IP, Inc. All significant intercompany accounts and transactions have been eliminated. The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and notes required by GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring items) considered necessary for a fair presentation have been included. Operating results for the three and nine months ended April 30, 2011, are not necessarily indicative of the results that may be expected for the fiscal year ending July 31, 2011. These unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements of the Company for the year ended July 31, 2010, and notes thereto filed with the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission (“SEC”) on October 12, 2010 (the “Annual Report”).

Note 2.  Comprehensive Income

Comprehensive income was $1,829,000 and $3,814,000 for the three and nine months ended April 30, 2011.  The Company’s only component of other comprehensive income is the foreign currency translation adjustment.

Note 3. Summary of Significant Accounting Policies>

Deferred revenue:  During the second quarter of fiscal 2011, the Company received a payment from Codman & Shurtleff, Inc. (“Codman”), a marketing partner, to establish exclusivity on certain generator products and accessories.  Revenue from the payment has been deferred and is being amortized over the expected term of the agreement.  The Company recognized $135,000 and $199,000, respectively, of this deferred revenue for the three and nine months ended April 30, 2011.  In addition, included in deferred revenue is an amount the Company received pursuant to a Confidential Settlement and License Agreement with Alcon, Inc. (“Alcon”).  This payment was accounted for as an up-front licensing fee.  Recognition of the revenue pursuant to this agreement has been deferred and is being recognized over a period of up to fifteen years based upon estimated shipments to Alcon under a related Supply Agreement executed pursuant to the settlement.  The Company recognized $157,000 and $388,000, respectively, of this deferred revenue as the estimate of these shipments has been revised for the three and nine months ended April 30, 2011.


The Company’s significant accounting policies are disclosed in the Annual Report. In the first nine months of fiscal 2011, no significant accounting policies were changed other than the deferred revenue policy discussed above.

Note 4. Marketing Partner Agreements>

The Company sells most of its electrosurgery generators and neurosurgery instruments and accessories to two U.S. based, global marketing partners as described below:

Codman

In the neurosurgical market, the bipolar electrosurgical system manufactured by Valley Forge prior to the merger has been sold for over 25 years through a series of distribution agreements with Codman, an affiliate of Johnson & Johnson.  On April 2, 2009, the Company executed a new, three-year distribution agreement with Codman for the continued distribution by Codman of certain bipolar generators and related disposables and accessories effective January 1, 2009.  In addition, the Company entered into a new, three-year license agreement, which provides for the continued licensing of the Company’s Malis® trademark to Codman for use with certain Codman products, including those covered by the distribution agreement.  Both agreements expire on December 31, 2011 and may renew for an additional three year period.  In December 2010, Codman elected to exercise its option of exclusive distribution with respect to the bipolar generators and related disposables and accessories.

On November 16, 2009, the Company announced the signing of an addendum to its three-year agreement with Codman.  Under the terms of the revised agreement, Codman has the exclusive right to market and distribute the Company’s Malis® SpetzlerTM branded disposable forceps produced by Synergetics.  Codman began distribution of the disposable bipolar forceps on December 1, 2009, domestically and February 1, 2010, internationally.

Total sales to Codman and its respective percent of the Company’s net sales for the three and nine months ended April 30, 2011 and 2010, including the historical sales of generators, accessories and disposable cord tubing that the Company has supplied in the past, as well as the disposable bipolar forceps sales resulting from the addendum to the existing distribution agreement and revenue recognized from the exclusivity payment, were as follows (dollars in thousands):

   
Three Months Ended
April 30, 2011
   
Three Months Ended
April 30, 2010
   
Nine Months Ended
April 30, 2011
   
Nine Months Ended
April 30, 2010
 
Net Sales
  $ 2,892     $ 2,304     $ 7,419     $ 4,777  
Percent of net sales
    19.7 %     16.6 %     18.5 %     12.2 %

Stryker Corporation (“Stryker”)

The Company supplies a lesion generator used for minimally invasive pain treatment to Stryker pursuant to a supply and distribution agreement dated as of October 25, 2004. The original term of the agreement was for slightly over five years, commencing on November 11, 2004 and ending on December 31, 2009. On August 1, 2007, the Company negotiated a one-year extension to the agreement through December 31, 2010 and increased the minimum purchase obligation to 300 units per year for the remaining contract period.  The Company has negotiated a four-year extension to the agreement through December 31, 2015.

On March 31, 2010, the Company entered into an additional strategic agreement with Stryker including the sale of accounts receivable, open sales orders, inventory and certain intellectual property related to the Omni® ultrasonic aspirator product line. For fiscal year 2010, the gain from the sale of the Omni® product line to Stryker was $817,000.  In the second quarter of fiscal 2011, the Company recorded an additional $99,000 loss on the sale of this product line, as certain receivables were deemed uncollectible.  In addition, the agreement provides for the Company to supply disposable ultrasonic instrument tips and certain other consumable products used in conjunction with the ultrasonic aspirator console and handpieces and to pursue certain development projects for new products associated with Stryker’s ultrasonic aspirator.  This agreement expires on March 31, 2014.

 
7


Total sales to Stryker and its respective percent of the Company’s net sales for the three and nine months ended April 30, 2011 and 2010, including the historical sales of pain control generators and accessories that the Company has supplied in the past, as well as the disposable ultrasonic instrument tips sales and certain other consumable products resulting from the new agreements, were as follows (dollars in thousands):

   
Three Months Ended
April 30, 2011
   
Three Months Ended
April 30, 2010
   
Nine Months Ended
April 30, 2011
   
Nine Months Ended
April 30, 2010
 
Net Sales
  $ 1,943     $ 1,640     $ 5,299     $ 2,898  
Percent of net sales
    13.2 %     11.8 %     13.2 %     7.4 %

No other customer comprises more than 10 percent of sales in any given quarter.


Stock Option Plans

The following table provides information about stock-based awards outstanding at April 30, 2011:

   
Shares
   
Weighted Average Exercise Price
   
Weighted Average Fair Value
 
Options outstanding beginning of period
    576,695     $ 2.08     $ 1.71  
For the period August 1, 2010 through April 30, 2011
                       
Granted
    108,751     $ 4.43     $ 3.56  
Forfeited
    (27,000 )   $ 3.21     $ 2.71  
Exercised
    (141,417 )   $ 1.49     $ 1.29  
Options outstanding, end of period
    517,029     $ 2.68     $ 2.16  
                         
Options exercisable, end of period
    354,028     $ 2.51     $ 2.02  

During the second quarter of fiscal 2011, there were 40,000 options granted to the Company’s independent directors, which vest pro-ratably on a quarterly basis over the next year of service.  Each independent director receives an option to purchase 10,000 shares of the Company’s Common Stock each year in which he or she is elected, appointed, or re-elected to serve as a director pursuant to the Amended and Restated 2005 Non-Employee Directors’ Stock Option Plan. The Company recorded $35,000 and $47,000, respectively, of compensation expense for each of the three and nine months ended April 30, 2011 related to these options.  In addition, the Company recorded $0 and $18,000, respectively, of compensation expense for the three and nine months ended April 30, 2011, for previously granted options.

During the second quarter of fiscal 2011, there were options to purchase 68,751 shares of Common Stock granted to the officers of the Company. These options were granted in conjunction with the Company’s annual review of compensation as of August 1, 2010 and vest pro-ratably on a quarterly basis over the next five years of service. The Company recorded $12,000 and $16,000, respectively, of compensation expense for the three and nine months ended April 30, 2011 related to these options.  In addition, the Company recorded $8,000 and $24,000, respectively, of compensation expense for the three and nine months ended April 30, 2011 for previously granted options.


The fair value of all options granted during the second fiscal quarter was determined at the date of the grant using the Black-Scholes options-pricing model and the following assumptions:

Expected average risk-free interest rate
    3.30 %
Expected average life (in years)
    10  
Expected volatility
    75.38 %
Expected dividend yield
    0.0 %

The expected average risk-free rate is based on the 10 year U.S. treasury yield curve in December of 2010.  The expected average life represents the period of time that the options granted are expected to be outstanding giving consideration to the vesting schedules, historical exercises and forfeiture patterns.  Expected volatility is based on historical volatilities of the Company’s Common Stock.  The expected dividend yield is based on historical information and management’s plan.

The intrinsic value of in-the-money stock options outstanding was $1.4 million and $24,000 at April 30, 2011 and 2010, respectively.  The intrinsic value of in-the-money exercisable stock options was $1.0 million and $296,000 at April 30, 2011 and 2010, respectively.

The Company expects to issue new shares as options are exercised. As of April 30, 2011, the future compensation cost expected to be recognized for currently outstanding stock options is approximately $55,000 for the remainder of fiscal 2011, $130,000 in fiscal 2012, $68,000 in fiscal 2013, $68,000 in fiscal 2014, $56,000 in fiscal 2015 and $20,000 in 2016.

Restricted Stock Plans

Under our Amended and Restated Synergetics USA, Inc. 2001 Stock Plan (“2001 Plan”), Common Stock may be granted at no cost to certain employees and consultants of the Company. Certain plan participants are entitled to cash dividends and voting rights for their respective shares. Restrictions limit the sale or transfer of these shares during a vesting period whereby the restrictions lapse either pro-ratably over a three to five-year vesting period or at the end of the fifth year. These shares also vest upon a change of control event. Upon issuance of stock under the 2001 Plan, unearned compensation equivalent to the market value at the date of the grant is charged to stockholders’ equity and subsequently amortized to expense over the applicable restriction period. As of April 30, 2011, there was approximately $452,000 of total unrecognized compensation cost related to non-vested share-based compensation arrangements granted under the 2001 Plan. The cost is expected to be recognized over a weighted average period of three to five years. The following table provides information about restricted stock grants during the nine-month period ended April 30, 2011:

   
Number of Shares
   
Weighted Average Grant Date Fair Value
 
Balance as of July 31, 2010
    286,961     $ 2.04  
Granted
    43,846     $ 4.43  
Forfeited
    --       --  
Balance as of April 30, 2011
    330,807     $ 2.36  

Note 6. Fair Value Information>

Fair value is an exit price that represents the amount that would be received upon sale of an asset or paid to transfer a liability in an orderly transaction between market participants.

The Company has no financial assets which are required to be measured at fair value on a recurring basis. Non-financial assets such as goodwill, intangible assets and property, plant and equipment are measured at fair value when there is an indicator of impairment and recorded at fair value only when impairment is recognized. No impairment indicators existed as of April 30, 2011.

 
9


The carrying amounts of cash and cash equivalents, accounts receivable, accounts payable and accrued expenses approximate fair value because of the short maturity of these items. The carrying amount of the Company’s notes payable is estimated to approximate fair value because the variable interest rates or the fixed interest rates are based on estimated current rates offered to the Company for debt with similar terms and maturities.

Note 7. Supplemental Balance Sheet Information>

Accounts Receivable and Allowance for Doubtful Accounts: The Company maintains allowances for doubtful accounts for estimated probable losses resulting from the inability of the Company’s customers to make required payments. The Company continues to assess the adequacy of the reserves for doubtful accounts based on the financial condition of the Company’s customers and other external factors that may impact collectability. The majority of the Company’s accounts receivable are due from trade customers, primarily in the hospital or ambulatory surgery center environment. Credit is extended based on an evaluation of the customers’ financial condition and generally, collateral is not required. Payment terms vary and accounts receivable are stated in the Condensed, Consolidated Financial Statements at amounts due from customers net of an allowance for doubtful accounts. Accounts outstanding for longer than the payment terms are considered past due. The Company considers a number of factors in determining the allowance for doubtful accounts, including the length of time trade accounts receivable are past due, the customers’ current ability to pay their obligations to the Company, the Company’s previous loss history, and the condition of the general economy and the medical industry as a whole. The Company writes off accounts receivable when they become uncollectible. The Company’s accounts receivable balance at April 30, 2011 reflects an allowance for doubtful accounts of $310,000 and at July 31, 2010 of $282,000.

Inventories: Inventories as of April 30, 2011 and July 31, 2010 were as follows (dollars in thousands):

   
April 30, 
2011
   
July 31,
2010
 
Raw material and component parts
  $ 5,962     $ 5,225  
Work in progress
    2,611       2,050  
Finished goods
    4,950       4,616  
    $ 13,523     $ 11,891  

Property and Equipment: Property and equipment as of April 30, 2011 and July 31, 2010 were as follows (dollars in thousands):

   
April 30,
2011
   
July 31,
2010
 
Land
  $ 730     $ 730  
Building and improvements
    5,965       5,929  
Machinery and equipment
    6,858       6,136  
Furniture and fixtures
    729       736  
Software
    363       363  
Construction in progress
    722       232  
      15,367       14,126  
Less accumulated depreciation
    6,681       6,082  
    $ 8,686     $ 8,044  

 
10


Other Intangible Assets:  Information regarding the Company’s other intangible assets as of April 30, 2011 and July 31, 2010 is as follows (dollars in thousands):

   
Gross Carrying Value
   
Accumulated Amortization
   
Net
 
   
April 30, 2011
 
Proprietary know-how
  $ 4,057     $ 1,730     $ 2,327  
Trademark
    5,923       --       5,923  
Licensing agreement
    5,834       2,162       3,672  
Patents
    1,617       576       1,041  
    $ 17,431     $ 4,468     $ 12,963  
                         
   
July 31, 2010
 
Proprietary know-how
  $ 4,057     $ 1,544     $ 2,513  
Trademark
    5,923       --       5,923  
Licensing agreement
    5,834       1,917       3,917  
Patents
    1,387       517       870  
    $ 17,201     $ 3,978     $ 13,223  

Goodwill of $10,660,000 and proprietary know-how of $4,057,000 are a result of the reverse merger transaction completed on September 21, 2005.

The Company did not incur costs to renew or extend the term of acquired intangible assets during the period ended April 30, 2011. Estimated amortization expense on other intangibles for the remaining three months of the fiscal year ending July 31, 2011, and the next four years thereafter is as follows (dollars in thousands):

   
Amount
 
Fiscal Year 2011 (remaining 3 months)
  $ 147  
Fiscal Year 2012
    587  
Fiscal Year 2013
    618  
Fiscal Year 2014
    617  
Fiscal Year 2015
    617  

Amortization expense for the three and nine months ended April 30, 2011 was $147,000 and $490,000, respectively.

Pledged assets; short and long-term debt (excluding revenue bonds payable):  Short-term debt as of April 30, 2011 and July 31, 2010, consisted of the following:

Revolving Credit Facility: The Company has a credit facility with a bank which allows for borrowings of up to $9.5 million (collateral available on April 30, 2011 permits borrowings up to $7.3 million) with an interest rate based on either the one-, two- or three-month LIBOR plus 2.0 percent and adjusting each quarter based upon our leverage ratio. As of April 30, 2011, interest under the facility is charged at 2.21 percent. The unused portion of the facility is charged at a rate of 0.20 percent. There were no borrowings under this facility at April 30, 2011. Outstanding amounts are collateralized by the Company’s domestic receivables and inventory. This credit facility was amended on November 30, 2010, to extend the termination date through November 30, 2011.

The facility has two financial covenants: a maximum leverage ratio of 3.75 times and a minimum fixed charge coverage ratio of 1.1 times. As of April 30, 2011, the leverage ratio was 1.02 times and the minimum fixed charge coverage ratio was 3.17 times. Collateral availability under the line as of April 30, 2011, was approximately $7.3 million. The facility restricts the payment of dividends if, following the distribution, the fixed charge coverage ratio would fall below the required minimum.

 
11


Non-U.S. Receivables Revolving Credit Facility:  The Company had a non-U.S. receivables credit facility with a bank which allowed for borrowings of up to $1.75 million with an interest rate based upon LIBOR plus 3.0 percent.  Pursuant to the terms of this facility, under no circumstances shall the rate be less than 3.5 percent per annum.  The facility charged an administrative fee of 1.0 percent.  Outstanding amounts were collateralized by the Company’s non-U.S. receivables.  This credit facility had no financial covenants or outstanding balance when it was terminated on November 30, 2010.

Equipment Line of Credit: Under this credit facility, the Company may borrow up to $1.0 million, with interest at one-month LIBOR plus 3.0 percent.  Pursuant to the terms of the equipment line of credit, under no circumstances shall the rate be less than 3.5 percent per annum.  The unused portion of the facility is not charged a fee. There were no borrowings under this facility at April 30, 2011. The equipment line of credit was amended on November 30, 2010, to extend the maturity date to November 30, 2011.

Long-term debt as of April 30, 2011 and July 31, 2010 consisted of the following (dollars in thousands):

   
April 30,
2011
   
July 31,
2010
 
Note payable to the estate of the late Dr. Leonard I. Malis, due in quarterly installments of $159,904 which includes interest at an imputed rate of 6.0 percent; remaining balance of $480,000 including the effects of imputing interest, due December 2011, collateralized by the Malis® trademark
  $ 466     $ 911  
Settlement obligation to Iridex Corporation (“Iridex”), due in annual installments of $800,000 which includes interest at an imputed rate of 8.0 percent; remaining balance of $800,000 including the effects of imputing interest, due April 15, 2012
    740       1,426  
Total
  $ 1,206     $ 2,337  
Less: current maturities
    1,206       1,398  
Long-term portion
  $ --     $ 939  

Deferred Revenue:  Deferred revenue as of April 30, 2011 and July 31, 2010, consisted of the following (dollars in thousands):

   
April 30,
2011
   
July 31,
2010
 
Deferred revenue -  Alcon Settlement
  $ 18,642     $ 19,030  
Deferred revenue – Codman Exclusivity
    401       --  
Total
  $ 19,043     $ 19,030  
Less: Short-term
    982       400  
Long-term portion
  $ 18,061     $ 18,630  

Note 8. Commitments and Contingencies

Effective January 29, 2009, the Company’s Board of Directors appointed David M. Hable to serve as President and Chief Executive Officer (“CEO”). Also on that date, the Company entered into a change in control agreement with Mr. Hable. On December 9, 2009, the Company entered into a change in control agreement with each of its Chief Operating Officer and Chief Scientific Officer, which agreements were contemplated in conjunction with the Company’s annual review of compensation and therefore, the agreements were made effective with other compensation changes as of August 1, 2009. On October 12, 2010, the Company entered into a change of control agreement with its Chief Financial Officer (“CFO”), which agreement was contemplated in conjunction with the Company’s annual review of compensation; therefore, the agreement was made effective with other compensation changes as of August 1, 2010.  On March 3, 2011, the Company entered into a change of control agreement with each of its Vice President of Domestic Sales and Vice President of International Sales and Marketing, which agreements were contemplated in conjunction with the Company’s annual review of compensation; therefore, the agreements were made effective with other compensation changes as of August 1, 2010. The change in control agreements with its executive officers, Vice President of Domestic Sales and Vice President of International Sales and Marketing each provide that if employment is terminated within one year following a change in control for cause or disability (as each term is defined in the change in control agreement), as a result of the officer’s death, or by the officer other than as an involuntary termination (as defined in the change in control agreement), the Company shall pay the officer all compensation earned or accrued through his or her employment termination date, including (i) base salary; (ii) reimbursement for reasonable and necessary expenses; (iii) vacation pay; (iv) bonuses and incentive compensation; and (v) all other amounts to which they are entitled under any compensation or benefit plan of the Company (“Standard Compensation Due”).

 
12


If the officer’s employment is terminated within one year following a change in control without cause and for any reason other than death or disability, including an involuntary termination, and provided the officer enters into a separation agreement within 30 days of his or her employment termination, he or she  shall receive the following: (i) all Standard Compensation Due and any amount payable as of the termination date under the Company’s objectives-based incentive plan, the sum of which shall be paid in a lump sum immediately upon such termination; and (ii) an amount equal to one times his or her annual base salary at the rate in effect immediately prior to the change in control, to be paid in 12 equal monthly installments beginning in the month following his or her employment termination. Furthermore, all of the officer’s awards of shares or options shall immediately vest and be exercisable for one year after the date of his or her employment termination.

Various claims, incidental to the ordinary course of business, are pending against the Company.  In the opinion of management, after consultation with legal counsel, resolution of these matters is not expected to have a material effect on the accompanying financial statements.

The Company is subject to regulatory requirements throughout the world. In the normal course of business, these regulatory agencies may require companies in the medical device industry to change their products or operating procedures, which could affect the Company.  The Company regularly incurs expenses to comply with these regulations and may be required to incur additional expenses.  Management is not able to estimate any additional expenditures outside the normal course of operations which will be incurred by the Company in future periods in order to comply with these regulations.

Note 9. Enterprise-wide Sales Information

Enterprise-wide sales information for the three and nine months ended April 30, 2011 and 2010, respectively, consisted of the following (dollars in thousands):

   
Three Months Ended
April 30, 2011
   
Three Months Ended
April 30, 2010
   
Nine Months Ended
April 30, 2011
   
Nine Months Ended
April 30, 2010
 
Net Sales
                       
Ophthalmic
  $ 9,226     $ 7,776     $ 25,038     $ 23,100  
Neurosurgery - Direct
    339       2,038       1,383       7,767  
Marketing Partners (Codman, Stryker)
    2,256       1,818       6,268       2,280  
Total Neurosurgery
    2,595       3,856       7,651       10,047  
OEM (Codman, Stryker, Iridex)
    2,840       2,195       7,289       5,776  
Other
    34       32       71       97  
Total
  $ 14,695     $ 13,859     $ 40,049     $ 39,020  
                                 
Net Sales
                               
Domestic
  $ 9,975     $ 9,408     $ 27,929     $ 26,648  
International
    4,720       4,451       12,120       12,372  
    $ 14,695     $ 13,859     $ 40,049     $ 39,020  

 
13


Note 10. Recent Accounting Pronouncements>

In January 2010, the Financial Accounting Standards Board (“FASB”) issued the Accounting Standards Update (“ASU”) No. 2010-06, “Improving Disclosures about Fair Value Measurements,” which amends Accounting Standards Codification 820, “Fair Value Measurements and Disclosures.” This ASU requires disclosures of transfers into and out of Levels 1 and 2, more detailed roll forward reconciliations of Level 3 recurring fair value measurement on a gross basis, fair value information by class of assets and liabilities and descriptions of valuation techniques and inputs for Level 2 and 3 measurements. The effective date for the roll forward reconciliations is the first quarter of fiscal 2012. The Company does not believe the adoption of this ASU will have a material effect on its consolidated financial statements.

We have reviewed all other recently issued, but not yet effective, accounting pronouncements and do not believe any such pronouncements will have a material impact on our financial statements.

Item 2 — Management’s Discussion and Analysis of Financial Condition and Results of Operations

Overview

Synergetics USA, Inc. is a leading supplier of precision microsurgical devices. The Company’s primary focus is on the microsurgical disciplines of ophthalmology and neurosurgery. Our distribution channels include a combination of direct and independent sales organizations and important strategic alliances with market leaders. The Company’s product lines focus upon precision engineered, microsurgical devices and the delivery of various energy modalities for the performance of minimally invasive microsurgery, including: (i) laser energy, (ii) ultrasonic energy, (iii) radio frequency energy for electrosurgery and lesion generation and (iv) visible light energy for illumination, and where applicable, simultaneous infusion (irrigation) of fluids into the operative field. Enterprise-wide sales information is included in Note 9 to the unaudited condensed consolidated financial statements.

The Company is a Delaware corporation incorporated on June 2, 2005, as a result of the reverse merger of Synergetics, Inc. and Valley Forge Scientific Corp. Synergetics was founded in 1991. Valley Forge was incorporated in 1980 and became a publicly-held company in November 1989. Prior to the reverse merger of Synergetics and Valley Forge, Valley Forge’s common stock was listed on The NASDAQ Small Cap Market (now known as The NASDAQ Capital Market) and the Boston Stock Exchange under the ticker symbol “VLFG.” On September 21, 2005, Synergetics Acquisition Corporation, a wholly owned Missouri subsidiary of Valley Forge, merged with and into Synergetics, and Synergetics thereby became a wholly owned subsidiary of Valley Forge. On September 22, 2005, Valley Forge reincorporated from a Pennsylvania corporation to a Delaware corporation and changed its name to Synergetics USA, Inc. Upon consummation of the merger, the Company’s securities began trading on The NASDAQ Capital Market under the ticker symbol “SURG,” and its shares were voluntarily delisted from the Boston Stock Exchange.

Recent Developments

We had several developments in fiscal 2010 and fiscal 2011 that we expect will contribute to the growth of our business in the foreseeable future.

On April 1, 2010, the Company announced the closing of a definitive agreement with Stryker in conjunction with the acquisition by Stryker of certain assets from Mutoh Co., Ltd. and its affiliates, used to produce the Sonopet Ultrasonic Aspirator control consoles and handpieces (previously marketed under the Omni® brand by Synergetics in the U.S., Canada and several other countries). The agreement included the sale of accounts receivable, open sales orders, inventory and certain intellectual property related to the Omni® product line. The gain from the sale of the Omni® product line to Stryker was $817,000 in fiscal 2010. In the second quarter of fiscal 2011, the Company recorded a $99,000 loss on the sale of this product line, as certain receivables were deemed to be uncollectible.  In addition, the agreement provides for the Company to supply disposable ultrasonic instrument tips and certain other consumable products used in conjunction with the Sonopet/Omni® ultrasonic aspirator console and handpieces, and pursue certain development projects for new products associated with Stryker’s ultrasonic aspirator products. The Company has negotiated a four-year extension to the agreement with Stryker through December 31, 2015.  The Stryker relationship has been proceeding well and is meeting the Company’s expectations for unit and dollar sales volumes.

 
14


On November 16, 2009, the Company announced the signing of an addendum to its three-year agreement (effective as of January 1, 2009) with Codman. Under the terms of the revised agreement, Codman has the exclusive right to market and distribute the Company’s Malis® branded disposable bipolar forceps. Codman began the domestic distribution of the disposable bipolar forceps on December 1, 2009 and the international distribution on February 1, 2010. The Codman relationship has been proceeding well and is meeting the Company’s expectations for unit and dollar sales volumes.

Contribution margins for the products supplied to Codman and Stryker have increased, as anticipated, primarily due to the elimination of commercial expenses associated with the distribution of these products.  However, sales and gross profit for these products have decreased, as the transfer prices to Codman and Stryker are lower than the previous average direct selling prices.

On April 27, 2010, the Company announced that it had entered into a Settlement and License Agreement with Alcon pursuant to which Alcon agreed to pay the Company $32.0 million, and the Company agreed to produce certain products for distribution by Alcon. The net proceeds to the Company were $21.4 million after contingency payments to attorneys. The Company recognized a gain from this agreement of $2.4 million in the third fiscal quarter of 2010. The remaining $19.0 million has been accounted for as deferred revenue on the balance sheet.  As units are shipped to Alcon under a Supply Agreement entered pursuant to the settlement, the Company will be paid an incremental transfer price.  In addition, the Company will recognize a portion of the deferred revenue as the estimate of these shipments to Alcon over a period of up to fifteen years is revised. The Company recognized $388,000 of this deferred revenue during the first nine months of fiscal 2011.  Shipments to Alcon of the first of two products covered by the agreement are expected to begin in the first quarter of fiscal 2012.

On October 26, 2010, the Company announced record sales leads generated from the presentation of recently released ophthalmic products at the 2010 Annual Meeting of the American Academy of Ophthalmology.

On November 30, 2010, the Company extended its revolving credit facility and its equipment line of credit through November 30, 2011.

On December 9, 2010, the Company announced that it signed a product development and consulting agreement with Retinal Solutions, LLC located in Michigan.

On December 22, 2010, Codman elected to exercise its option of exclusive distribution with respect to the bipolar generators and related disposables and accessories.

On February 16, 2011, the Company retired the debt on its O’Fallon, Missouri facility.

On March 10, 2011, the Company reported that it had begun selling the VersaPACKTM for use in the vitreoretinal operating room.  The launch of this product allows the Company to compete in an estimated $277 million segment of the vitreoretinal market in which we previously were unable to compete.

 
15


Summary of Financial Information

The following tables present net sales by category and our results of operations (dollars in thousands):

NET SALES BY CATEGORY

   
Three Months Ended
 
       
   
April 30, 2011
   
Mix
   
April 30, 2010
   
Mix
 
                         
Ophthalmology
  $ 9,226       62.8 %   $ 7,776       56.1 %
Direct Neurosurgery
    339       2.3 %     2,038       14.7 %
Marketing Partners (1)
    2,256       15.4 %     1,818       13.1 %
Total Neurosurgery
    2,595       17.7 %     3,856       27.8 %
Original Equipment Manufacturers (“OEM”) (2)
    2,840       19.3 %     2,195       15.9 %
Other
    34       0.2 %     32       0.2 %
Total
  $ 14,695             $ 13,859          

   
Nine Months Ended
 
       
   
April 30, 2011
   
Mix
   
April 30, 2010
   
Mix
 
                         
Ophthalmology
  $ 25,038       62.5 %   $ 23,100       59.2 %
Direct Neurosurgery
    1,383       3.4 %     7,767       19.9 %
Marketing Partners (1)
    6,268       15.7 %     2,280       5.8 %
Total Neurosurgery
    7,651       19.1 %     10,047       25.7 %
OEM
    7,289       18.2 %     5,776       14.8 %
Other
    71       0.2 %     97       0.3 %
Total
  $ 40,049             $ 39,020          

 
(1)
Marketing partners’ sales include disposable bipolar forceps, disposable ultrasonic instrument tips and accessories which were previously sold by our direct neurosurgery sales force and our distribution partners.  These products have been transitioned to our marketing partners.
 
(2)
Revenues from OEM represent sales of electrosurgical and pain control generators, related accessories, certain laser probes and deferred revenue to Codman, Stryker, Iridex and Alcon.

The increase in sales for the third quarter of fiscal 2011 compared with the third quarter of fiscal 2010 was primarily due to an increase of $1.5 million in ophthalmic sales and a $645,000 increase in OEM sales (including $292,000 of deferred revenue recognized), partially offset by a $1.3 million decrease in our neurosurgery sales due to the transition of the majority of our neurosurgery product sales to our marketing partners.  In the third quarter of fiscal 2010, the Company sold $187,000 of Omni® capital equipment that was previously included in our direct neurosurgery sales and which the Company no longer sells.  Overall sales of capital equipment in the third quarter of fiscal 2011, including the sales of Omni® capital equipment, declined by $707,000, or 25.1 percent, compared with the third quarter of fiscal 2010.  However, the sales of our disposable products grew $1.3 million, or 11.8 percent, in the third quarter of fiscal 2011 as compared to the third quarter fiscal 2010.

 
16


The increase in sales for the first nine months of fiscal 2011 compared with the first nine months of fiscal 2010 was primarily due to a $1.9 million increase in ophthalmology sales and a $1.5 million increase in OEM sales (including $587,000 of deferred revenue recognized), partially offset by a $2.4 million decrease in total neurosurgery sales due to the transition of the majority of our neurosurgery product sales to our marketing partners.  In the first nine months of fiscal 2010, the Company sold $1.1 million of Omni® capital equipment that was previously included in our direct neurosurgery sales and which the Company no longer sells.  Overall sales of our capital equipment in the first nine months of fiscal 2011, including the sales of Omni® capital equipment, declined by $2.2 million, or 23.9 percent, compared with the first nine months of fiscal 2010.  However, the sales of our disposable products grew $2.7 million, or 9.1 percent, in the first nine months of fiscal 2011 as compared to the first nine months of fiscal 2010.

RESULTS OF OPERATIONS
(Dollars in Thousands)

   
Three Months Ended
 
   
April 30, 2011
   
April 30, 2010(2)
   
Increase
(Decrease)
 
Net Sales
  $ 14,695     $ 13,859       6.0 %
Gross Profit
    8,547       8,031       6.4 %
Gross Profit Margin %
    58.2 %     57.9 %     0.5 %
Commercial Expenses
                       
Sales and Marketing
    2,771       2,896       (4.3 %)
General and Administrative
    2,427       2,204       10.1 %
Research and Development
    882       886       (0.5 %)
Operating Income
    2,467       2,045       20.6 %
Operating Margin
    16.8 %     14.8 %     13.5 %
EBITDA (1)
    2,899       5,815       (50.1 %)
Net Income
  $ 1,643     $ 3,309       (50.3 %)
Earnings per share
  $ 0.07     $ 0.13       (46.2 %)
Return on equity (1)
    3.4 %     8.0 %     (57.5 %)
Return on assets (1)
    2.2 %     5.2 %     (57.7 %)

   
Nine Months Ended
 
   
April 30, 2011
   
April 30, 2010(2)
   
Increase
(Decrease)
 
Net Sales
  $ 40,049     $ 39,020       2.6 %
Gross Profit
    23,303       22,373       4.2 %
Gross Profit Margin %
    58.2 %     57.3 %     1.6 %
Commercial Expenses
                       
Sales and Marketing
    8,528       9,200       (7.3 %)
General and Administrative
    6,854       6,286       9.0 %
Research and Development
    2,587       2,320       11.5 %
Operating Income
    5,334       4,567       16.8 %
Operating Margin
    13.3 %     11.7 %     13.7 %
EBITDA (1)
    6,618       9,258       (28.5 %)
Net Income
  $ 3,596     $ 4,728       (23.9 %)
Earnings per share
  $ 0.14     $ 0.19       (26.3 %)
Return on equity (1)
    7.8 %     11.8 %     (33.9 %)
Return on assets (1)
    5.1 %     8.3 %     (38.6 %)
_______
(1)
EBITDA, return on equity and return on assets are not financial measures recognized by U.S. GAAP.  EBITDA is defined as income before net interest expense, income taxes, depreciation and amortization.    Return on equity is defined as net income divided by average equity.  Return on assets is defined as net income plus interest expense divided by average assets.  See disclosure following regarding the use of non-GAAP financial measures.
(2)
In the three and nine months ended April 30, 2010, the Company experienced two one-time items:
 
(a)  gain from sale of product line to Stryker resulted in income of $893,000, net income of $566,000 and earnings per share of $0.02 and (b)  settlement proceeds from Alcon resulted in income of $2.4 million, net income of $1.5 million and earnings per share of $0.06.

 
17


Reconciliation of Non-GAAP Financial Measures

   
Three Months Ended
(Dollars in Thousands)
   
Nine Months Ended
(Dollars in Thousands)
 
   
April 30,
2011
   
April 30,
 2010
   
April 30,
 2011
   
April 30,
 2010
 
EDITDA Reconciliation
                       
Net Income
  $ 1,643     $ 3,309     $ 3,596     $ 4,728  
Interest
    37       113       182       412  
Income taxes
    809       1,909       1,528       2,667  
Depreciation and amortization
    410       484       1,312       1,451  
EBITDA
  $ 2,899     $ 5,815     $ 6,618     $ 9,256  

   
Three Months Ended
(Dollars in Thousands)
   
Nine Months Ended
(Dollars in Thousands)
 
   
April 30,
2011
   
April 30,
 2010
   
April 30,
2011
   
April 30,
 2010
 
Return on Equity Calculation
                       
Net Income
  $ 1,643     $ 3,309     $ 3,596     $ 4,728  
Average Equity:
                               
April 30, 2011
  $ 48,627             $ 48,627          
January 31, 2011
  $ 46,621             $ 46,621          
October 31, 2010
                  $ 45,167          
July 31, 2010
                  $ 44,226          
April 30, 2010
          $ 43,096             $ 43,096  
January 31, 2010
          $ 39,708             $ 39,708  
October 31, 2009
                          $ 38,746  
July 31, 2009
                          $ 38,130  
Average Equity
  $ 47,624     $ 41,402     $ 46,160     $ 39,920  
Return on Equity
    3.4 %     8.0 %     7.8 %     11.8 %
 
   
Three Months Ended
(Dollars in Thousands)
   
Nine Months Ended
(Dollars in Thousands)
 
   
April 30,
2011
   
April 30,
2010
   
April 30,
2011
   
April 30,
 2010
 
Return on Assets Calculation
                       
Net Income
  $ 1,643     $ 3,309     $ 3,596     $ 4,728  
Interest
    37       113       182       412  
Net income + interest Expense
  $ 1,680     $ 3,422     $ 3,778     $ 5,414  
Average Assets:
                               
April 30, 2011
  $ 74,181             $ 74,181          
January 31, 2011
  $ 75,270             $ 75,270          
October 31, 2010
                  $ 74,143          
July 31, 2010
                  $ 73,095          
April 30, 2011
          $ 75,085             $ 75,085  
January 31, 2010
          $ 56,996             $ 56,996  
October 31, 2009
                          $ 56,737  
July 31, 2009
                          $ 58,080  
Average Assets
  $ 74,726     $ 66,041     $ 73,806     $ 61,725  
Return on Assets
    2.2 %     5.2 %     5.1 %     8.3 %

 
18

 
   
Three Months Ended
(Dollars in Thousands)
   
Nine Months Ended
(Dollars in Thousands)
 
   
April 30,
2011
   
April 30,
 2010
   
April 30,
2011
   
April 30,
2010
 
Table of Income and EPS
                       
Income from Stryker gain (loss)
  $ --     $ 893     $ (99 )   $ 817  
Income from Alcon settlement
  $ --     $ 2,398     $ --     $ 2,398  
Income from Operations
  $ 2,452     $ 1,927     $ 5,223     $ 4,180  
Total Income
  $ 2,452     $ 5,218     $ 5,124     $ 7,395  
Effective Tax Rate
    33.0 %     36.6 %     29.8 %     36.1 %
Net Income from Stryker gain (loss)
  $ --     $ 566     $ (69 )   $ 522  
Net income from Alcon settlement
  $ --     $ 1,521     $ --     $ 1,533  
Net Income from Operations
  $ 1,643     $ 1,222     $ 3,665     $ 2,673  
Total Net Income
  $ 1,643     $ 3,309     $ 3,596     $ 4,728  
Average weighted shares outstanding
    24,945,707       24,701,260       24,878,768       24,579,928  
Earnings per shares from Stryker gain (loss)
  $ 0.00     $ 0.02     $ 0.00     $ 0.02  
Earnings per shares from Alcon settlement
  $ 0.00     $ 0.06     $ 0.00     $ 0.06  
Net income from operations
  $ 0.07     $ 0.05     $ 0.14     $ 0.11  
Total Earnings Per Share
  $ 0.07     $ 0.13     $ 0.14     $ 0.19  

We measure our performance primarily through our operating profit.  In addition to our consolidated financial statements presented in accordance with GAAP, management uses certain non-GAAP measures, including EBITDA, return on equity and return on assets, to measure our operating performance.  We provide a definition of the components of these measurements and a reconciliation to the most directly comparable GAAP financial measure.  In addition, there were two one-time events the Company experienced in fiscal 2010 which we believe needed to presented separately to accurate reflect the results of operations.

These non-GAAP measures are presented to enhance an understanding of our operating results and are not intended to represent cash flow or results of operations.  The use of these non-GAAP measures provides an indication of our ability to service debt and measure operating performance.  We believe these non-GAAP measures are useful in evaluating our operating performance compared to other companies in our industry. We believe these metrics are beneficial to investors, potential investors and other key stakeholders, including creditors who use this measure in their evaluation of our performance.

EBITDA, however, does have certain material limitations primarily due to the exclusion of certain amounts that are material to our results of operations, such as interest expense, income tax expense, depreciation and amortization.  Due to these limitations, EBITDA should not be considered a measure of discretionary cash available to us to invest in our business and should be utilized in conjunction with other information contained in our consolidated financial statements prepared in accordance with GAAP.

 
19


Results Overview

Product categories as a percentage of total sales were as follows:

   
Three Months Ended
 
   
April 30,
 2011
   
April 30,
 2010
 
Ophthalmology
    62.8 %     56.1 %
Direct Neurosurgery
    2.3 %     14.7 %
Marketing Partners
    15.4 %     13.1 %
OEM
    19.3 %     15.9 %
Other
    0.2 %     0.2 %
Total
    100.0 %     100.0 %

   
Nine Months Ended
 
   
April 30,
 2011
   
April 30,
 2010
 
Ophthalmology
    62.5 %     59.2 %
Direct Neurosurgery
    3.4 %     19.9 %
Marketing Partners
    15.7 %     5.8 %
OEM
    18.2 %     14.8 %
Other
    0.2 %     0.3 %
Total
    100.0 %     100.0 %

International revenues of $4.7 million, or 32.1 percent, of our total revenues for the three months ended April 30, 2011, as compared to $4.5 million, or 32.1 percent, as of the three months ended April 30, 2010. For the nine months ended April 30, 2011, international revenues were $12.1 million, or 30.3 percent, as compared to $12.4 million, or 31.7 percent, for the nine months ended April 30, 2010.  Many of the products we sell to our marketing partners and OEM customers are shipped to their non-U.S. customers in various countries around the world, but are included in our domestic revenues.

Our Business Strategy

The Company’s key strategy is to enhance shareholder value through profitable revenue growth in ophthalmology and neurosurgery markets. This is accomplished through the identification and development of reusable and disposable devices in conjunction with leading surgeons and marketing partners.  We are committed to establishing a strong operational infrastructure and financial foundation within which growth opportunities can be prudently evaluated, financed and implemented. We will remain vigilant and sensitive to new challenges which may arise from changes in the definition and delivery of appropriate healthcare in our fields of interest. In fiscal 2011, our strategic priorities are to drive the Company onto a higher growth trajectory and to continue to enhance the profitability of our operational platform by focusing on manufacturing efficiencies.

In fiscal 2011, we continue to be focused on the following strategies>:

Improve Profitability and Cash Efficiency through:

Manufacturing Efficiencies

Lean Manufacturing — During the fiscal year ended July 31, 2010, we implemented lean manufacturing in virtually all of our disposable illumination and laser probe product lines. We restructured our production operations from a traditional departmental model into five value streams. Each value stream has a dedicated management team to support the production, technical and quality aspects of our products. Lean concepts were also implemented within select machining and instrument value streams with great success. We will continue to implement our lean initiative throughout the production value streams and expand into our accounting operations in fiscal 2011. We estimate that we realized approximately $1.4 million of direct labor cost savings from these initiatives during fiscal 2010 and $438,000 during the first nine months of fiscal 2011.  In addition, we have entered the phase in which we are conducting Kaizen events (Kaizen in Japanese means “change for the better”), which we anticipate will produce significant incremental cost savings.

 
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Component Cost Savings — The Company’s most recent acquisition, Medimold, LLC, is producing plastic components which were previously supplied by outside vendors and realizing additional benefits related to the compression of time and costs in the new product development cycle.  We continue to save on the conversion of select high volume machined parts to injection molded, plastic parts. Our annual savings from these conversions was approximately $200,000 during fiscal year 2010 and 2011. In addition, the Company continues to pursue select outsourcing opportunities for high volume components.

Supply Chain Management — During fiscal 2009, the Company implemented Material Requirements Planning (“MRP”) in planning and controlling its production processes. The implementation of MRP helped reduce days of inventory on hand from 265 days at July 31, 2008 compared with 233 days at July 31, 2009 and 196 days at July 31, 2010. Days of inventory on hand increased to 222 days as of April 30, 2011 due to the Company’s preparation for new product launches and a decision to increase our domestic and international inventory to make sure customer demands are being fulfilled on a timely basis.  The Company is in the process of implementing a new Enterprise Resource Planning (“ERP”) System and is anticipated that it will be installed in the first quarter of fiscal 2012.

Human Resource Rationalization — Starting with a hiring freeze in October 2008 and ending with a reduction in force in July 2009 of approximately 40 people, including our direct neurosurgery sales force, the Company redeployed certain human resources and reduced the number of employees and temporary workers by 10.0 percent during fiscal 2009. These changes were made possible by the introduction of manufacturing efficiencies in certain product lines, the implementation of improvements in our enterprise-wide information system, the implementation of MRP and supply chain management and related consolidations, and the shift from direct sales of certain neurosurgery products in the U.S. to the sales of these same products through marketing partners. The hiring freeze has continued through the third quarter of fiscal 2011 and certain positions are only added based upon a specific resource need or a replacement hire. At April 30, 2011, our head count was 355 as compared with 356 at July 31, 2010. A fully staffed operation, including planned replacements, is approximately 360 employees.

Cash Management — The Company has been focused on its debt level which it reduced to $1.2 million as of April 30, 2011 and intends to continue to monitor its leverage by focusing on the reduction in days sales in accounts receivable and inventory. During the third quarter of fiscal 2011, the Company’s leverage ratio (defined as debt divided by debt plus total stockholders’ equity) was 2.4 percent, which was a decline from 8.4 percent as of July 31, 2010. 

Accelerate Growth through:

Research & Development (“R&D”) — In order to focus resources on the most important projects, in October 2008, the Company completed a thorough review of its R&D efforts.  The process implemented at that time has led to a reduction in the number of active projects in the R&D pipeline to 27 at April 30, 2011. In addition, we developed a uniform policies and procedures manual for our top ten R&D initiatives. In July 2009, the Company reorganized its R&D resources into an advanced technology group which works on longer-term, highly complex R&D initiatives, a primary development group which works on strategically targeted products and a manufacturing engineering group which works on product line extensions. These three groups continue to focus on projects in both ophthalmology and neurosurgery. Additionally, the engineering team at the King of Prussia, Pennsylvania location has been strengthened to provide capacity for the development of new electrosurgery products.

 
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New Business Development — The Company’s core assets, including a history of customer driven innovation, quality differentiated products and an extensive distribution network, make it a logical component of value-creating business combinations. We continue to evaluate such potential opportunities that can expand the Company’s product offerings.

Assess Distribution Alternatives:

The Company competes in two distinct medical device markets, ophthalmology and neurosurgery. These markets are very different in terms of the number and size of the competitors in each and the size and maturity of their respective distribution networks. The Company has successfully effected the transition of the distribution of its neurosurgery products to its marketing partners.

Improve Sales Force Productivity:

The professionalism and productivity of the Company’s sales force is one of its  assets. Significant effort was made in the last fiscal year to align the incentives and promotional direction of the sales force with those of the Company. This change resulted in enhanced productivity during fiscal 2011.

In fiscal 2011, our driving strategic priorities are>:

 
·
To move the Company onto a higher growth trajectory. This means, simply, new products, some in new categories. Our top four R&D projects will allow us access to different categories within the vitreoretinal and intracranial markets to drive organic growth, along with new business development opportunities that the Company is aggressively pursuing. We believe that this focus will revitalize the Company’s compound annual growth rate.

 
·
To continue to enhance the profitability of our operational platform by focusing on our manufacturing efficiencies, including lean manufacturing and select outsourcing of high quality components, and cost savings. In the third quarter of fiscal 2011, we enhanced our operating margins from 14.8 percent to 16.8 percent when compared to the third quarter of fiscal 2010.

New Product Sales

The Company’s business strategy has been, and is expected to continue to be, the development, manufacture and marketing of new technologies for microsurgery applications included in the ophthalmic and neurosurgical markets. New products, which management defines as products first available for sale within the prior 24-month period, accounted for approximately 11.9 percent of total sales for the Company for the nine months ended April 30, 2011, or approximately $4.8 million for the nine months ended April 30, 2011.  In order to focus resources on the most important projects, the Company completed a thorough review of its R&D efforts and reorganized these resources in fiscal 2009.  The Company currently has 27 active projects in its R&D pipeline, including a small core of significant projects.  Due to the advanced technical challenges presented by these core projects, it will take a longer time for a significant impact on revenue to come to fruition.

Demand Trends

The Company’s sales increased 2.6 percent during the first nine months of fiscal 2011 compared with the first nine months of fiscal 2010.  The two most significant factors impacting this increase were an additional $1.9 million in ophthalmology sales and a $1.5 million increase in OEM sales during the first nine months of fiscal 2011.  These increases were partially offset by a $2.4 million decrease in total neurosurgery sales due to the transition of the majority of our neurosurgery product sales to our marketing partners.  Overall sales of our capital equipment in the first nine months of fiscal 2011, including the sales of Omni® capital equipment, declined by $2.2 million, or 23.9 percent, compared with the first nine months of fiscal 2010.  However, the sales of our disposable products grew $2.7 million, or 9.1 percent, in the first nine months of fiscal 2011 as compared to the first nine months of fiscal 2010.

 
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A study performed by Market Scope LLC in February 2011 predicts a steady growth of 3.6 percent per year in vitrectomy surgery worldwide driven by an increase in the elderly population worldwide, an increase in the number of surgeons, an increase in the number of diseases treated with vitrectomy and an increase in frequency of diabetic complications due to the obesity epidemic.  Based upon this growth in procedures, sales of retinal surgical products are forecast to increase to $1.7 billion in 2016, reflecting a compound annual growth rate of 9.0 percent when compared to 2011.

Neurosurgical procedures on a global basis continue to rise at an estimated 2 to 3 percent growth rate driven by an aging global population, new technologies, advances in surgical techniques and a growing global market resulting from ongoing improvements in healthcare delivery in third world countries, among other factors.  Based upon this growth in procedures, sales of neurosurgical products are forecast to increase by 4 percent.

In addition, the demand for high quality, innovate products and new technologies consistent with the Company’s devices and disposables will continue to favorably impact procedure growth in the ophthalmic and neurosurgical markets.

Pricing Trends

     The Company has generally been able to maintain the average selling prices for its products in the face of downward pressure in the healthcare industry. However, increased competition for the Company’s capital equipment market segments, in combination with customer budget constraints, capital scarcity and the transition of procedures to the ambulatory surgery center, has the potential to negatively impact the Company’s selling prices on these devices. The Company has no major domestic group purchasing agreements.

Economic Trends

Economic conditions may continue to negatively impact capital expenditures at the hospital or surgical center and physician level. Further, global economic conditions are negatively impacting the volume and average selling price of the Company’s capital equipment.

Results Overview

During the fiscal quarter ended April 30, 2011, the Company recorded net sales of $14.7 million, which generated $8.5 million in gross profit, operating income of $2.5 million and net income of approximately $1.6 million, or $0.07 earnings per share. The Company had $17.0 million in cash and $1.2 million in interest-bearing debt and revenue bonds as of April 30, 2011. Management anticipates that its available cash and cash flows from operations will be sufficient to meet working capital, capital expenditure and debt service needs for the next twelve months.

 
23


Results of Operations

Three-Month Period Ended April 30, 2011 Compared to Three-Month Period Ended April 30, 2010

Net Sales

The following table presents net sales by category (dollars in thousands):


 
 
Quarter Ended
 
 
 
April 30, 2011
   
April 30, 2010
   
% Increase
(Decrease)
 
Ophthalmic
  $ 9,226     $ 7,776       18.6 %
Direct Neurosurgery
    339       2,038       (83.4 %)
Marketing partners (Codman, Stryker)
    2,256       1,818       24.1 %
Total Neurosurgery
    2,595       3,856       (32.7 %)
OEM (Codman, Stryker, Iridex, Alcon)
    2,840       2,195       29.4 %
  Other
    34       32       6.3 %
Total
  $ 14,695     $ 13,859       6.0 %

Ophthalmic sales grew 18.6 percent in the third quarter of fiscal 2011 compared to the third quarter of fiscal 2010. Domestic and international ophthalmic sales increased 11.7 percent and 26.6 percent, respectively, primarily due to increased sales of disposable products.  Direct neurosurgery sales decreased $1.7 million, or 83.4 percent, to $339,000 in the third quarter of fiscal 2011 compared to the third quarter of fiscal 2010. This decline in neurosurgery sales was the result of the transition of the majority of our direct neurosurgery distribution to Codman and Stryker under marketing partner agreements.  Sales to our domestic marketing partners increased by $438,000 in the third quarter of fiscal 2011, partially offsetting the loss in direct neurosurgery sales. Total OEM rose 29.4 percent to $2.8 million (including $292,000 of deferred revenue recognized) compared with $2.2 million in the third quarter of fiscal 2010.

The increase in sales in the third quarter of fiscal 2011 compared with the third quarter of fiscal 2010 was primarily due to increased ophthalmic disposable, marketing partner and OEM sales.  Certain aspects of our capital equipment sales and the transition of our direct neurosurgery sales to our marketing partners partially offset these sales increases.  In the third quarter of fiscal 2010, the Company sold $187,000 of Omni® capital equipment, which was previously included in our direct neurosurgery sales and which the Company no longer sells.  Sales of capital equipment in the third quarter of fiscal 2011, including the sales of Omni® capital equipment, declined by $707,000, or 21.5 percent, compared with the third quarter of fiscal 2010.  However, the sales of our disposable products grew $1.3 million, or 11.8 percent, in the third quarter of fiscal 2011 as compared to the third fiscal quarter fiscal 2010.

The following table presents domestic and international net sales (dollars in thousands):

   
Three Months Ended
 
   
April 30, 2011
   
April 30, 2010
   
% Increase
(Decrease)
 
                   
Domestic (including Marketing Partner and OEM sales)
  $ 9,975     $ 9,408       6.0 %
International  (including Canada)
    4,720       4,451       6.0 %
Total
  $ 14,695     $ 13,859       6.0 %

Domestic sales increased 6.0 percent due to increases in ophthalmic, OEM and marketing partner sales which are all, except for ophthalmic, recorded as domestic sales.  International sales increased 6.0 percent as the increase in international ophthalmology sales of 26.6 percent offset the decline in international neurosurgery sales due to the shift in sales from direct international neurosurgery sales to our marketing partners as these sales are included in domestic revenue.

 
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Gross Profit

Gross profit as a percentage of net sales was 58.2 percent in the third quarter of fiscal 2011, compared to 57.9 percent for the same period in fiscal 2010.  Gross profit as a percentage of net sales for the third quarter of fiscal 2011 compared to the third quarter of fiscal 2010 increased 0.3 percentage points due to the impact of the improved margins on our ophthalmology products and the recognition of deferred revenue from our OEM partners, partially offset by the margin impact of the transition of the majority of our direct neurosurgery sales to our marketing partners.  The Company continues to realize incremental savings from the lean manufacturing initiative and continues to develop our internal resources to expand the initiative throughout the entire organization.

Operating Expenses

R&D expenses as a percentage of net sales was 6.0 percent and 6.4 percent for the third quarter of fiscal 2011 and 2010, respectively. R&D costs remained flat in the third quarter of fiscal 2011 compared to the same period in fiscal 2010.  The Company’s pipeline included approximately 27 active projects in various stages of completion as of April 30, 2011.  The Company’s R&D investment is driven by the opportunities to develop new products to meet the needs of its customers, and reflecting the need to keep such spending in line with what the Company can afford to spend, results in an investment rate that the Company believes is comparable to such spending by other medical device companies.  The Company expects over the next few years to invest in R&D at a rate of approximately 5 to 7 percent of net sales.

Sales and marketing expenses decreased by approximately $125,000 to $2.8 million, or 18.9 percent of net sales, for the third fiscal quarter of 2011, compared to $2.9 million, or 20.9 percent of net sales, for the third fiscal quarter of 2010. The decrease in sales and marketing expenses as a percentage of net sales was primarily due to the elimination of our neurosurgery sales force as of July 31, 2009.

General and administrative expenses increased by approximately $223,000 to $2.4 million, or 16.5 percent of net sales, in the third fiscal quarter of 2011, compared to $2.2 million, or 15.9 percent of net sales, for the third fiscal quarter of 2010. The increase in general and administrative expenses as a percentage of net sales was primarily due to additional employees required to manage the implementation our lean manufacturing and quality improvement initiatives.

Other Income/(Expenses)

 Other expense for the third quarter of fiscal 2011 increased to $15,000 compared to an income of $3.2 million for the third quarter of fiscal 2010.  The increase in other expenses was primarily due to the one-time gains recorded in the third quarter of fiscal 2010. In the three months ended April 30, 2010, the Company experienced two one-time items:  a gain from the sale of product line to Stryker resulted in income of $893,000 and a settlement with Alcon resulted in income of $2.4 million.

Operating Income, Income Taxes and Net Income

Operating income for the third quarter of fiscal 2011 was up $422,000 to $2.5 million, as compared to the comparable 2010 fiscal period. The higher operating income was primarily the result of a 6.0 percent increase in sales (including $292,000 in deferred revenue) and a 4.3 percent decrease in sales and marketing expense, partially offset by a 5.5 percent increase in cost of sales and a 10.1 percent increase in general and administrative expenses.

The Company recorded a $809,000 tax provision on pre-tax income of $2.5 million, a 33.0 percent tax provision, in the quarter ended April 30, 2011.  In the quarter ended April 30, 2010, the Company recorded a $1.9 million tax provision on pre-tax income of $5.2 million, a 36.6 percent tax provision.  The decrease in the effective tax rate was primarily due to the higher level of net income recorded in the third quarter of fiscal 2010 resulting from the two one-time items:  a gain from the sale of product line to Stryker and a settlement with Alcon.

 
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Net income decreased by $1.7 million to $1.6 million for the third quarter of fiscal 2011, from $3.3 million for the same period in fiscal 2010. The decrease in net income was primarily from the two one-time items which were recognized in the third quarter of fiscal 2010.  Basic and diluted earnings per share for the third quarter of fiscal 2011 decreased to $0.07 from $0.13 for the third quarter of fiscal 2010.  Basic weighted average shares outstanding increased from 24,701,260 at April 30, 2010, to 24,945,707 at April 30, 2011.

Nine-Month Period Ended April 30, 2011 Compared to Nine-Month Period Ended April 30, 2010

Net Sales

The following table presents net sales by category (dollars in thousands):

 
 
Nine Months Ended
 
 
 
April 30, 2011
   
April 30, 2010
   
% Increase
(Decrease)
 
Ophthalmic
  $ 25,038     $ 23,100       8.4 %
Direct Neurosurgery
    1,383       7,767       (82.2 %)
Marketing partners (Codman, Stryker)
    6,268       2,280       174.9 %
Total Neurosurgery
    7,651       10,047       (23.9 %)
OEM (Codman, Stryker, Iridex, Alcon)
    7,289       5,776       26.2 %
Other
    71       97       (26.8 %)
Total
  $ 40,049     $ 39,020       2.6 %

Ophthalmic sales grew 8.4 percent in the first nine months of fiscal 2011 compared to the first nine months of fiscal 2010. Domestic and international ophthalmic sales increased 1.7 percent and 17.3 percent, respectively, due to the increase in disposable sales.  Neurosurgery sales decreased $2.4 million, or 23.9 percent, to $7.7 million in the first nine months of fiscal 2011 compared the first nine months of fiscal 2010. This decline in neurosurgery sales was the result of the transition of the majority of our direct neurosurgery distribution to Codman and Stryker under marketing partner agreements.  Sales to our domestic marketing partners increased $4.0 million in the first nine months of fiscal 2011. Total OEM sales rose 26.2 percent to $7.3 million (including $587,000 of deferred revenue recognized) compared with $5.8 million in the first nine months of fiscal 2010.

The increase in sales in the first nine months of fiscal 2011 compared with the first nine months of fiscal 2010 was primarily due to increased ophthalmic disposables, marketing partner and OEM sales.  Certain aspects of our capital equipment sales and the transition of our direct neurosurgery sales to our marketing partners partially offset the sales increase.  In the first nine months of fiscal 2010, the Company sold $1.1 million of Omni® capital equipment, which was previously included in our direct neurosurgery sales and which the Company no longer sells.  Sales of capital equipment in the first nine months of fiscal 2011 declined by $2.2 million, or 23.9 percent, compared with the first nine months of fiscal 2010.  However, the sales of our disposable products grew $2.7 million, or 9.1 percent, in the first nine months of fiscal 2011 as compared to the first nine months of fiscal 2010.

The following table presents domestic and international net sales (dollars in thousands):

   
Nine Months Ended
 
   
April 30, 2011
   
April 30, 2010
   
% Increase
(Decrease)