e424b3
Prospectus Supplement No. 5 to Prospectus dated March 30, 2007
Filed Pursuant to Rule 424(b)(3)
Registration Statement No. 333-123866
Endocare, Inc.
Supplement No. 5
to
Prospectus Dated March 30, 2007
This is a Supplement to Endocare, Inc.s Prospectus, dated March 30, 2007, with respect
to the offer and sale of up to 3,193,375 shares (9,580,126 shares prior to the one-for-three
reverse stock split that we completed on August 20, 2007) of our common stock by the selling
securityholders listed herein or their transferees. This Supplement amends and supplements certain
information contained in the Prospectus. You should read this Supplement carefully.
Endocare is a specialty medical device company focused on improving patients lives through
the development, manufacturing and distribution of health care products for cryoablation. The term
cryoablation or cryosurgery refers to the use of ice to destroy tissue, such as tumors, for
therapeutic purposes. Today, our FDA-cleared Cryocare Surgical System occupies a growing position
in the urological market for treatment of prostate and renal cancer. We believe our proprietary
cryosurgical technologies also have broad applications across a number of other surgical markets,
including for the treatment of tumors in the lung and liver and palliative intervention (treatment
of pain associated with metastases).
Our common stock is traded on The NASDAQ Capital Market under the symbol ENDO. On November
1, 2007, the last reported sale price of our common stock on The NASDAQ Capital Market was $8.03
per share.
YOU SHOULD CAREFULLY CONSIDER THE RISK FACTORS FOR OUR SHARES, WHICH ARE LISTED IN THE
PROSPECTUS.
Neither the Securities and Exchange Commission nor any state securities commission has
approved or disapproved of the securities to be issued under this Supplement and the Prospectus or
determined if this Supplement or the Prospectus is truthful or complete. Any representation to the
contrary is a criminal offense.
The
date of this prospectus supplement is November 6, 2007
QUARTERLY REPORT ON FORM 10-Q
On
November 6, 2007, we filed our Quarterly Report on Form 10-Q for the quarter ended
September 30, 2007, a copy of which is included below.
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
(Mark One)
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þ |
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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2007
OR
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o |
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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: 001-15063
Endocare, Inc.
(Exact name of Registrant as Specified in Its Charter)
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DELAWARE
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33-0618093 |
(State of Incorporation)
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(I.R.S. Employer I.D. No.) |
201 TECHNOLOGY DRIVE, IRVINE, CALIFORNIA 92618
(Address of Principal Executive Office, Including Zip Code)
(949) 450-5400
(Registrants Telephone Number, Including Area Code)
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. (1) Yes þ No o; (2) Yes
þ No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated
filer, or a non-accelerated filer. See definitions of accelerated filer and large accelerated
filer in Rule 12b-2 of the Exchange Act. (Check one):
Large Accelerated Filer o Accelerated Filer þ Non-Accelerated Filer o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of
the Exchange Act). Yes o No þ
The number of shares of the Registrants common stock, par value $.001 per share, outstanding
at September 30, 2007 was 11,594,895.
Endocare, Inc.
INDEX
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3 |
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3 |
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4 |
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5 |
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6 |
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15 |
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27 |
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27 |
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29 |
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29 |
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30 |
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30 |
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30 |
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30 |
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30 |
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31 |
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2
PART I FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements
ENDOCARE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
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Three Months Ended September 30, |
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Nine Months Ended September 30, |
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2007 |
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2006 |
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2007 |
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2006 |
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(Unaudited) |
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(In thousands, except per share data) |
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Total revenues |
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$ |
7,326 |
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$ |
6,700 |
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$ |
22,773 |
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$ |
20,870 |
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Costs and expenses: |
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Cost of revenues |
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2,171 |
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2,677 |
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7,506 |
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9,699 |
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Research and development |
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699 |
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581 |
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1,935 |
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2,067 |
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Selling and marketing |
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3,500 |
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3,725 |
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11,362 |
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11,398 |
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General and administrative |
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2,881 |
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3,196 |
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9,556 |
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9,262 |
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Litigation settlement, net of related legal
expenses |
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(677 |
) |
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(677 |
) |
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Total costs and expenses |
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8,574 |
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10,179 |
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29,682 |
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32,426 |
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Loss from operations |
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(1,248 |
) |
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(3,479 |
) |
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(6,909 |
) |
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(11,556 |
) |
Interest expense related to common stock
warrants |
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1,245 |
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2,941 |
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Interest income, net |
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264 |
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|
85 |
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|
402 |
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434 |
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Loss from continuing operations before taxes |
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(984 |
) |
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(2,149 |
) |
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(6,507 |
) |
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(8,181 |
) |
Tax benefit on continuing operations |
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151 |
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Loss from continuing operations |
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(984 |
) |
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(2,149 |
) |
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(6,507 |
) |
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(8,030 |
) |
Income from discontinued operations
(including gain on disposal of $0.5 million in
2006), net of taxes |
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245 |
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Net loss |
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$ |
(984 |
) |
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$ |
(2,149 |
) |
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$ |
(6,507 |
) |
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$ |
(7,785 |
) |
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Net income (loss) per share basic and diluted: |
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Continuing operations |
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$ |
(0.08 |
) |
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$ |
(0.21 |
) |
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$ |
(0.59 |
) |
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$ |
(0.80 |
) |
Discontinued operations |
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$ |
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$ |
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$ |
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$ |
0.02 |
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Weighted average shares of common stock
outstanding |
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11,595 |
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10,058 |
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10,947 |
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10,054 |
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The accompanying notes are an integral part of these condensed consolidated financial statements.
3
ENDOCARE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
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September 30, |
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December 31, |
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2007 |
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2006 |
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(Unaudited) |
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(In thousands, except |
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per share data) |
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ASSETS |
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Current assets: |
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Cash and cash equivalents |
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$ |
7,569 |
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$ |
1,811 |
|
Accounts receivable, net |
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3,581 |
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4,161 |
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Inventories, net |
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2,702 |
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2,260 |
|
Prepaid expenses and other current assets |
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2,083 |
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1,284 |
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Litigation settlement receivable |
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1,100 |
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Total current assets |
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17,035 |
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9,516 |
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Property and equipment, net |
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769 |
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1,040 |
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Intangibles, net |
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3,203 |
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3,613 |
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Investments and other assets |
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988 |
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2,077 |
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Total assets |
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$ |
21,995 |
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$ |
16,246 |
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LIABILITIES AND STOCKHOLDERS EQUITY |
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Current liabilities: |
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Accounts payable |
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$ |
3,173 |
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$ |
3,393 |
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Accrued compensation |
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3,258 |
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3,000 |
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Line of credit |
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880 |
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Other accrued liabilities |
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3,170 |
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3,594 |
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Total current liabilities |
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10,481 |
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9,987 |
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Other long term liabilities |
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237 |
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74 |
|
Common stock warrants |
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1,307 |
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Stockholders equity: |
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Preferred stock, $0.001 par value; 1,000
shares authorized; none issued and
outstanding |
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Common stock, $0.001 par value; 50,000
shares authorized; 11,595 and 10,226
issued and outstanding as of September
30, 2007 and December 31, 2006,
respectively |
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12 |
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10 |
|
Additional paid-in capital |
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198,586 |
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181,310 |
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Accumulated deficit |
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(187,321 |
) |
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(176,442 |
) |
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Total stockholders equity |
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11,277 |
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|
4,878 |
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Total liabilities and stockholders equity |
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$ |
21,995 |
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$ |
16,246 |
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The accompanying notes are an integral part of these condensed consolidated financial statements.
4
ENDOCARE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
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Nine Months Ended September 30, |
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2007 |
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2006 |
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(Unaudited) |
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(In thousands) |
|
Cash flows from operating activities: |
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Net loss |
|
$ |
(6,507 |
) |
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$ |
(7,785 |
) |
Adjustments to reconcile net loss to net cash used in operating activities: |
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Gain on divestiture |
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(418 |
) |
Revaluation of Plethora note receivable |
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(442 |
) |
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Depreciation and amortization |
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|
874 |
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|
1,227 |
|
Loss on sale of placement units and other fixed assets |
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|
52 |
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|
5 |
|
Extinguishment of payroll tax liabilities |
|
|
(121 |
) |
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|
(869 |
) |
Stock-based compensation |
|
|
2,949 |
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|
1,986 |
|
Net interest expense related to common stock warrants |
|
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|
|
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|
(2,941 |
) |
|
|
|
|
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|
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|
Changes in operating assets and liabilities: |
|
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|
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|
Accounts receivable |
|
|
581 |
|
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|
826 |
|
Inventories |
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|
(612 |
) |
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|
88 |
|
Prepaid expenses and other assets |
|
|
731 |
|
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|
430 |
|
Litigation settlement receivable, net of related legal expenses payable |
|
|
(677 |
) |
|
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|
Accounts payable |
|
|
(640 |
) |
|
|
392 |
|
Accrued compensation |
|
|
427 |
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|
(144 |
) |
Other liabilities |
|
|
(261 |
) |
|
|
(2,685 |
) |
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Net cash used in operating activities |
|
|
(3,646 |
) |
|
|
(9,888 |
) |
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Cash flows from investing activities: |
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Purchases of property and equipment |
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|
(76 |
) |
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|
(144 |
) |
Proceeds from divestitures |
|
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|
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|
7,287 |
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|
|
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|
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|
Net cash provided by (used in) investing activities |
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|
(76 |
) |
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|
7,143 |
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Cash flows from financing activities: |
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|
Stock options exercised |
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|
108 |
|
Net borrowings on line of credit |
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|
880 |
|
|
|
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|
Proceeds from sale of common stock |
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|
8,600 |
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|
|
|
|
|
|
|
|
|
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|
Net cash provided by financing activities |
|
|
9,480 |
|
|
|
108 |
|
|
|
|
|
|
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|
|
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|
|
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|
Net increase (decrease) in cash and cash equivalents |
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|
5,758 |
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|
(2,637 |
) |
Cash and cash equivalents, beginning of period |
|
|
1,811 |
|
|
|
8,108 |
|
|
|
|
|
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|
Cash and cash equivalents, end of period |
|
$ |
7,569 |
|
|
$ |
5,471 |
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-cash activities: |
|
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|
|
|
|
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|
Transfer of inventory to property and equipment for placement at customer sites |
|
$ |
273 |
|
|
$ |
361 |
|
Transfer of Cryocare Surgical Systems from property and equipment to inventory
for sale |
|
$ |
103 |
|
|
$ |
418 |
|
Note receivable received in divestiture |
|
$ |
|
|
|
$ |
1,425 |
|
Adoption of
FSP 00-19-2: |
|
|
|
|
|
|
|
|
Reduction of retained earnings |
|
$ |
4,373 |
|
|
$ |
|
|
Increase in additional paid-in capital |
|
$ |
5,680 |
|
|
$ |
|
|
Reduction of common stock warrant liability |
|
$ |
1,307 |
|
|
$ |
|
|
The accompanying notes are an integral part of these condensed consolidated financial statements.
5
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Tabular numbers in thousands, except per share data)
(Unaudited)
1. Organization and Operations
We are a medical device company focused on developing, manufacturing and selling cryoablation
products which have the potential to assist physicians in improving and extending life by use in
the treatment of cancer and other tumors. We were formed in 1990 as a research and development
division of Medstone International, Inc. (Medstone), a manufacturer of shockwave lithotripsy
equipment for the treatment of kidney stones. Following our incorporation under the laws of the
state of Delaware in 1994, we became an independent, publicly-owned corporation upon Medstones
distribution of our stock to the existing stockholders on January 1, 1996.
Through February 10, 2006, we also offered vacuum therapy systems for non-pharmaceutical
treatment of erectile dysfunction through our wholly-owned subsidiary Timm Medical Technologies,
Inc. (Timm Medical), which was sold to a third party effective February 10, 2006 (see Note 4 -
Sale of Timm Medical). The operating results of Timm Medical through the date of sale are
included in discontinued operations.
2. Basis of Presentation
Following the rules and regulations of the Securities and Exchange Commission (SEC), we have
omitted footnote disclosures in this report that would substantially duplicate the disclosures
contained in our annual audited financial statements. The accompanying condensed consolidated
financial statements should be read together with the consolidated financial statements and the
notes thereto included in our Annual Report on Form 10-K, filed with the SEC on March 16, 2007.
The accompanying condensed consolidated financial statements reflect all adjustments,
consisting solely of normal recurring accruals, needed to present fairly the financial results for
these interim periods. The condensed consolidated results of operations presented for the interim
periods are not necessarily indicative of the results for a full year. All intercompany
transactions and accounts have been eliminated in consolidation.
Effective on August 20, 2007, we effected a one-for-three reverse split of our common stock.
All share amounts and per share amounts have been adjusted throughout the condensed consolidated
financial statements and the related notes to reflect this reverse stock split for all periods
presented. The reverse split did not affect the authorized shares and par value per share. On
October 10, 2007, our common stock commenced trading on The NASDAQ Capital Market under the symbol ENDO.
3. Recent Operating Results and Liquidity
Since inception, we have incurred losses from operations and have reported negative cash
flows. As of September 30, 2007, we had an accumulated deficit of $187.3 million and cash and cash
equivalents of $7.6 million. Of the cash balance, $0.9 million is borrowed on our line of credit,
which is payable on a current basis. As of September 30, 2007, we have sold $1.6 million in stock
under our agreement with Fusion Capital Fund II, LLC (Fusion Capital) and $7.0 million in stock
to Frazier Healthcare V, L.P. (Frazier) as more fully described below.
We do not expect to reach cash flow positive operations on an annual basis in 2007, and we
expect to continue to generate losses from operations for the foreseeable future. These losses have
resulted in part from our continued investment to gain acceptance of our technology and investment
in initiatives that we believe should ultimately result in cost reductions. Although in July 2006
we resolved the investigations by the SEC and the Department of Justice (DOJ) of our historical
accounting and financial reporting (see Note 10 Commitments and Contingencies), we still have
obligations to indemnify and advance the legal fees of our former officers and former directors in
connection with the ongoing investigations and legal proceedings related to those individuals. We
expect that the amount of those legal fees will exceed the reimbursement due to us from our
directors and officers liability insurance, and the excess may have a material adverse effect on
our business, financial condition, results of operations and liquidity. For the nine months ended
September 30, 2007, we incurred expenses of $1.2 million
6
relating to legal fees of former officers and former directors and recorded insurance
recoveries of $0.8 million. As of September 30, 2007, there remained an aggregate of $0.2 million
available under this insurance coverage. For a description of this insurance coverage, please
refer to the Form 8-K that we filed on February 25, 2005 and Note 10 Commitments and
Contingencies.
We also face large cash expenditures in the future related to past due state and local tax
obligations, primarily sales and use taxes, which we estimate to be approximately $2.3 million.
The amount was fully accrued as of September 30, 2007. We are in the process of negotiating
resolutions of the past due state and local tax obligations with the applicable tax authorities.
However, there is no assurance that these obligations will be reduced as a result of the
negotiations or that we will be allowed to pay the amounts due over an extended period of time.
We also intend to continue investing in our sales and marketing efforts to physicians in order
to raise awareness and gain further acceptance of our technology. This investment is required in
order to increase physicians usage of our technology in the treatment of prostate and renal
cancers, lung and liver cancers and palliative intervention (treatment of pain associated with
metastases). Such costs will be reported as current period charges under generally accepted
accounting principles.
We received $7.0 million from the sale of our common stock to Frazier in May 2007. Our other
funding sources include a $16.0 million common stock purchase agreement with Fusion Capital and a
$4.0 million credit agreement with Silicon Valley Bank discussed below. The funding availability
under both agreements is subject to many conditions, some of which are predicated on events that
are not within our control. Under the Fusion Capital agreement, we are limited as to the amount of
stock we can sell each time. It also contains default provisions and is automatically suspended if
the trading prices of our shares fall below $3.00. In addition, the extent to which we rely on
Fusion Capital as a source of funding will depend on a number of factors including the prevailing
market price per share of our common stock. The bank credit facility contains restrictive covenants
and subjective acceleration clauses that permit the lender to accelerate payment of all outstanding
balances or cease to make further advances to us in the event of default or if the lender
determines in its judgment that a material adverse change has occurred or will occur. Although we
are in compliance with these conditions and covenants as of September 30, 2007, there is no
assurance that we will be able to comply with all requirements in future periods, that we can
obtain a waiver if an event of default occurs or that the lender will not exercise the subjective
acceleration clause. Accordingly, we cannot guarantee that these capital resources will be
available when needed or will be sufficient.
As of September 30, 2007, we had sold 293,397 shares of stock to Fusion Capital for total
gross proceeds of $1.6 million. Since we have authorized 2,666,666 shares for sale under the stock
purchase agreement, the selling price of our common stock to Fusion Capital would have to average
at least $6.00 per share for us to receive the maximum proceeds of $16.0 million. As of September
30, 2007, we had $0.9 million outstanding under the line of credit facility, which expires on
February 27, 2008. The terms of these agreements are described in Note 5 Private Placement of
Common Stock and Warrants, and Note 6 Bank Line of Credit.
Our continuing losses, cash flow deficits and obligations, along with the contingencies in our
funding sources, together raise substantial doubt about our ability to continue as a going concern.
The accompanying financial statements have been prepared assuming that we will continue as a going
concern and do not include any adjustments to reflect the possible future effects on the
recoverability and classification of assets or the amounts and classification of liabilities that
may result from the outcome of this uncertainty.
We expect to use existing cash reserves, working capital through the sale of our products, as
well as future proceeds from sales, if any, of common stock to Fusion Capital and borrowings under
our credit facility, to finance our projected operating and cash flow needs, along with continued
expense management efforts. We have reduced operating cash use over the past five years by
streamlining our corporate structure, focusing resources on our core products and strategic
initiatives, re-engineering our products to lower manufacturing costs, reducing use of consultants
and professional services and delaying or eliminating non-essential spending. We have also
instituted additional equity incentive programs to reduce cash compensation outlays.
We may borrow funds under our line of credit with our bank for short-term needs as long as we
remain in compliance with the representations, warranties, covenants and borrowing conditions. We
believe that the financing with Fusion Capital and our line of credit with our bank should provide
us with the capital resources that we need to reach the point where our operations will generate
positive cash flows on a consistent basis. However, our cash
7
needs are not entirely predictable. Even if we are able to access the full $16.0 million
under the common stock purchase agreement with Fusion Capital, we may still need additional capital
to fully implement our business, operating and development plans. In addition, if financing from
Fusion Capital were to prove unavailable or prohibitively dilutive and if we are unable to sell
enough of our products, we would need to secure another source of funding in order to satisfy our
working capital needs. Accordingly, we cannot guarantee the availability of these capital resources
or that they will be sufficient to fund our ongoing operations to the point where our operations
will generate positive cash flows on a consistent basis.
Because of the subjective acceleration clauses and other contingencies referred to above, the
audit report of our independent auditors contained in our Annual Report on Form 10-K filed on March
16, 2007 contains an unqualified opinion with an explanatory paragraph, to the effect that there is
substantial doubt about our ability to continue as a going concern. This opinion could itself have
a material adverse effect on our business, financial condition, results of operations and cash
flows.
4. Sale of Timm Medical
On January 13, 2006, we entered into a stock purchase agreement with Plethora Solutions Holdings
plc (Plethora), a company listed on the London Stock Exchange. Under this agreement Plethora
agreed to acquire Timm Medical, a wholly owned subsidiary of Endocare, for $9.5 million. The
transaction closed on February 10, 2006. After the sale, we did not receive significant direct
cash flows from Timm Medical and had no significant continuing involvement in its operations. In
accordance with Statement of Financial Accounting Standard (SFAS) No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets, the assets and liabilities of Timm Medical were
classified as discontinued operations in the condensed consolidated financial statements from the
date we decided to sell Timm Medical. Sale proceeds (net of $0.6 million in transaction costs)
totaled $8.9 million and resulted in a gain on sale of $0.5 million in the first quarter of 2006.
Gross proceeds of $9.5 million include cash of $8.1 million and a two-year, five percent promissory
note for $1.4 million which is secured by the assets of Timm Medical. The note is convertible into
Plethoras ordinary shares at any time at our option. If Plethoras shares trade above a specified
price for 20 consecutive days, Plethora has the option to require conversion. We had previously
been in discussions with Plethora to potentially accelerate the payment of the note for a lump sum
discounted amount. Based on these discussions we reserved $0.3 million of the note balance in the
fourth quarter of 2006 and ceased accruing interest income on the note. Since that time, our
discussions have ceased and we believe that it is unlikely that we would accept a discounted
payment amount on the note. As a result, during the three months ended September 30, 2007, we
eliminated the $0.3 million reserve and reinstated the note to its face value and recorded $0.1
million in interest income previously suspended. Net cash proceeds from the divestiture were $7.3
million after $0.6 million in transaction costs and $40,000 in cash of Timm Medical as of the date
of disposition.
We agreed to retain certain assets and liabilities of Timm Medical, including all tax
liabilities totaling $1.1 million, obligations and rights to a $2.7 million note receivable from
SRS Medical Corporation, relating to the sale of Timm Medicals urinary incontinence product line
in 2003, certain litigation to which Timm Medical was a party and ownership of Urohealth BV (Timm
Medicals wholly-owned subsidiary with insignificant operations). Assets and liabilities we
retained and their related revenues and expenses are excluded from discontinued operations. The
stock purchase agreement requires that payments under the promissory note described above be placed
in an indemnification escrow in certain circumstances to indemnify Plethora against certain claims
and liabilities.
Assets and liabilities sold to Plethora as of February 10, 2006 included the following:
|
|
|
|
|
Assets: |
|
|
|
|
Cash, inventories and other current assets |
|
$ |
1,041 |
|
Property and equipment, net |
|
|
71 |
|
Goodwill, net |
|
|
4,552 |
|
Intangibles, net |
|
|
3,680 |
|
Other assets |
|
|
65 |
|
|
|
|
|
Total assets |
|
|
9,409 |
|
|
|
|
|
|
|
|
|
|
Liabilities: |
|
|
|
|
Accounts payable and other current liabilities |
|
|
502 |
|
Other accrued liabilities |
|
|
486 |
|
|
|
|
|
Total liabilities |
|
|
988 |
|
|
|
|
|
|
|
|
|
|
Net assets |
|
$ |
8,421 |
|
|
|
|
|
8
Revenues for Timm Medical were $1.0 million (for the period from January 1, 2006 through date
of sale, February 10, 2006). Income from discontinued operations for the nine months ended
September 30, 2006 included a $0.5 million gain on disposal and is net of $0.2 million in taxes.
5. Private Placement of Common Stock and Warrants
May 2007 Private Placement
On May 24, 2007 we entered into a common stock subscription agreement with Frazier and on May
25, 2007 we entered into a registration rights agreement with Frazier. Under the subscription
agreement, Frazier agreed to purchase 1,085,271 shares of our common stock at a price per share of
$6.45, for aggregate proceeds to us of $7.0 million.
In the subscription agreement, Frazier agreed to lock-up provisions restricting the
transferability of the shares, for a period of one year for 75 percent of the shares and a period
of 18 months for 25 percent of the shares. The lock-up provisions expire early if we undergo a
change in control or if we issue significant additional amounts of securities in certain
circumstances after May 25, 2007, as described in the subscription agreement.
In the registration rights agreement, we agreed to file a registration statement with the SEC
on or before February 25, 2008 to register the shares for resale. We also agreed to use
commercially reasonable efforts to cause the registration statement to become effective as promptly
as possible thereafter, with the intention that the registration statement will be available for
resale by Frazier once the lock-up restrictions expire. In addition, we agreed to use commercially
reasonable efforts to keep the registration statement effective until May 25, 2010.
Fusion Capital Equity Purchase Agreement
On October 25, 2006, we entered into a common stock purchase agreement with Fusion Capital as
described above under Note 3 Recent Operating Results and Liquidity. Under this agreement we
have the right to sell to Fusion Capital up to $16.0 million worth of common stock, at our
election, over a two year period at prices determined based upon the market price of our common
stock at the time of each sale, without any fixed discount. Common stock may be sold in $100,000
increments every fourth business day, with additional $150,000 increments available every third
business day if the market price per share of our common stock is $4.50 or higher, subject to our
ability to comply with certain ongoing requirements discussed below. This $150,000 increment can be
further increased at graduated levels up to $1.0 million if the market price per share increases
from $4.50 to $18.00. If the price of the stock is below $3.00 per share, the obligation for Fusion
Capital to buy any shares of stock is automatically suspended. Under the terms of the agreement, we
issued 157,985 shares of common stock to Fusion Capital for no consideration as a commitment fee.
Under a related registration rights agreement, before Fusion Capital was obligated to purchase
shares, we were required to file a registration statement covering the sale of up to 2,824,652
common shares within 20 days of signing the agreement. The registration statement was filed in
November 2006 and declared effective by the SEC on December 1, 2006. We subsequently filed a
post-effective amendment to the registration statement, which was declared effective March 30,
2007. We are required to maintain effectiveness of the registration statement until the earlier of
the date that Fusion Capital may sell the shares without restriction pursuant to Rule 144(k) or the
date that Fusion Capital has sold all purchased shares and no available unpurchased shares remain
under the agreement. Upon occurrence of certain events of default as defined in the stock purchase
agreement, including lapse of effectiveness of the registration statement for 10 or more
consecutive business days or for 30 or more business days within a 365-day period, suspension of
trading for three business days, delisting of the shares from the principal market on which they
are traded, failure by our stock transfer agent to issue shares within five business days or other
material breaches, Fusion Capital may terminate the stock purchase agreement. We have the right to
terminate the agreement at any time.
9
Through September 30, 2007, we had sold 293,397 shares to Fusion Capital for gross proceeds of
$1.6 million. We are obligated to pay a transaction fee equal to 6.0 percent of the stock proceeds
to an investment advisory firm under a pre-existing capital advisory agreement. As of September 30, 2007, we have
approximately $14.4 million in remaining funding available with Fusion Capital based on our closing
stock price on that date.
March 2005 Private Placement
On March 11, 2005, we completed a private placement of 1,878,448 shares of our common stock
and detachable warrants to purchase 1,314,892 common shares at an offering price of $8.31 per
share, for aggregate gross proceeds of $15.6 million. Transaction costs were $1.0 million,
resulting in net proceeds of $14.6 million. Of the total warrants, 657,446 had an initial exercise
price of $10.50 (Series A warrants) per share and 657,446 had an initial exercise price of $12.00
(Series B warrants) per share. The expiration date of the warrants is May 1, 2010. One current
member and one former member of our management team made personal investments totaling $0.7 million
in the aggregate, and a member of our Board of Directors invested $0.3 million.
The warrants have an anti-dilution clause that is triggered upon issuance of a certain number
of shares of our common stock that reduces the effective exercise price of the warrants to preserve
the ownership of the warrant holders. As a result of our May 2007 private placement and the
issuance of shares to Fusion Capital through September 30, 2007, the exercise price of the Series A
Warrants decreased to $10.02 to effectively provide holders the right to purchase an additional
31,667 shares and the exercise price of the Series B Warrants decreased to $11.37 to effectively
provide holders the right to purchase an additional 37,191 shares.
The warrants initially are exercisable at any time during their term for cash only. The
warrants may be exercised on a cashless exercise basis in limited circumstances after the first
anniversary of the closing date if there is not an effective registration statement covering the
resale of the shares underlying the warrants. Each warrant is callable by us at a price of $0.01
per share underlying such warrant if our stock trades above certain dollar per share thresholds
($19.50 for the Series A warrants and $22.50 for Series B warrants) for 20 consecutive days
commencing on any date after the effectiveness of the registration statement, provided that (a) we
provide 30-day advanced written notice (Notice Period), (b) we simultaneously call all warrants on
the same terms and (c) all common shares issuable are registered. Holders may exercise their
warrants during the Notice Period and warrants which remain unexercised will be redeemed at $0.01
per share.
Upon exercise, we will pay transaction fees equal to 6.0 percent of the warrant proceeds under
a pre-existing capital advisory agreement.
Pursuant to the terms of the registration rights agreement relating to the March 2005
financing, we filed with the SEC a registration statement on Form S-2 under the Securities Act of
1933, as amended, covering the resale of all of the common stock purchased and the common stock
originally underlying the issued warrants. The S-2 registration statement was declared effective
September 28, 2005. We subsequently filed a post-effective amendment on Form S-3, which was
declared effective March 28, 2006 and a post-effective amendment on Form S-1, which was declared
effective March 30, 2007.
The registration rights agreement provides that if a registration statement is not filed
within 30 days of closing or does not become effective within 90 days thereafter, then in addition
to any other rights the holders may have, we will be required to pay each holder an amount in cash,
as liquidated damages, equal to one percent of the aggregate purchase price paid by such holder per
month. We incurred $0.6 million of liquidated damages through September 28, 2005, when the S-2
registration statement was declared effective.
Under the registration rights agreement, we could incur similar liquidated damages in the
future (equal to one percent of the aggregate purchase price paid by each affected holder per
month) if holders are unable to make sales under the registration statement (for example, if we
fail to keep the registration statement current as required by SEC rules or if future amendments to
the registration statement are not declared effective in a timely manner). The registration
obligation remains outstanding until the earlier of the date on which all shares issuable upon
exercise of the warrants have been issued and resold by the holders of the warrants or the date on
which all such shares can be resold by the holders without registration.
10
Since the liquidated damages under the registration rights agreement could in some cases
exceed a reasonable discount for delivering unregistered shares, we accounted for the registration
payment arrangement and warrants as one instrument classified as a derivative (a non-current
liability) under EITF No. 00-19, Accounting for Derivative Financial Instruments Indexed to, and
Potentially Settled in, a Companys Own Stock. We allocated a portion of the March 2005 offering
proceeds to the warrants based on their fair value at issuance. Through December 31, 2006, we
revalued the warrants as a derivative instrument quarterly in connection with changes in the
underlying stock price and other assumptions, with the change in value recorded as interest
expense. In December 2006, the Financial Accounting Standards Board issued FASB Staff Position
(FSP) No. 00-19-2, Accounting for Registration Payment Arrangements, which changed the way we
account for the outstanding warrants. FSP No. 00-19-2 specifies that the contingent obligation to
make future payments or otherwise transfer consideration under a registration payment arrangement
should be separately recognized and measured in accordance with SFAS No. 5, Accounting for
Contingencies. For registration payment arrangements and financial instruments subject to those
arrangements that were entered into prior to the issuance of this FSP and that continue to be
outstanding at the adoption date, this guidance is effective for fiscal years beginning after
December 15, 2006 and interim periods within those fiscal years. Upon adoption of FSP No. 00-19-2
on January 1, 2007, the value of the warrants as of the original issue date ($5.7 million) was
reclassified to equity without regard to the contingent obligation to transfer consideration under
the registration payment arrangement. The difference between the $5.7 million and the carrying
value of the warrant liability as of December 31, 2006 ($1.3 million) was recorded as a
cumulative-effect adjustment to reduce opening retained earnings on January 1, 2007. Hereafter,
accruals for liquidated damages, if any, will be recorded when they are probable and reasonably
estimable.
6. Bank Line of Credit
As described above in Note 3 Recent Operating Results and Liquidity, on October 26, 2005,
we entered into a one-year credit facility with Silicon Valley Bank (the lender), which provided up
to $4.0 million in borrowings for working capital purposes in the form of a revolving line of
credit and term loans (not to exceed $500,000). The agreement was amended in February, April and
December 2006 and was extended to February 28, 2007. In February 2007 the agreement was further
extended to February 27, 2008, as described below.
The credit facility permits the borrowings up to the lesser of $4.0 million or amounts
available under a borrowing base formula based on eligible accounts receivable and inventory. As
amended, the borrowing base is (i) 85 percent of eligible accounts receivable, plus (ii) the lesser
of 30 percent of the value of eligible inventory or $500,000. Borrowings are secured by all of our
assets, including all receivable collections which are held in trust for the Bank. Interest is
payable monthly at prime rate plus 1.5 percent. The agreement requires a one-time commitment fee of
$40,000 paid on the effective date and an annual facility fee equal to 0.5 percent of the unused
portion of the facility. A termination fee will also be assessed if the credit facility is
terminated prior to expiration. We had no outstanding borrowings at December 31, 2006. As of
September 30, 2007 there was $0.9 million outstanding on the line of credit.
As a condition to each advance under the credit facility, all representations and warranties
by us must be materially true and no event of default must have occurred or be continuing. In
addition, the lender, in its good faith business judgment, must determine that no material adverse
change has occurred. A material adverse change occurs when there is a material impairment in the
priority of the lenders lien in the collateral or its value, a material adverse change in our
business, operations or condition, a material impairment of the prospect of repayment or if the
lender determines, in its good faith reasonable judgment, that there is a reasonable likelihood
that we will fail to comply with one or more financial covenant in the next financial reporting
period.
The agreement governing the credit facility contains various financial and operating covenants
that impose limitations on our ability, among other things, to incur additional indebtedness, merge
or consolidate, sell assets except in the ordinary course of business, make certain investments,
enter into leases and pay dividends without the consent of the lender. The credit facility also
includes a subjective acceleration clause and a requirement to maintain a lock box with the lender
to which all collections are deposited. Under the subjective acceleration clause, the lender may
declare default and terminate the credit facility if it determines that a material adverse charge
has occurred. If the aggregate outstanding advances plus reserves placed by the lender against the
loan availability exceeds 50 percent of the receivable borrowing base component as defined, or if a
default occurs, all current and future lock box proceeds will be applied against the outstanding
borrowings. The credit facility also contains cross-default provisions and a minimum tangible net
worth requirement measured on a monthly basis. Tangible net worth must be
11
equal to or greater than the sum of a base amount ($1,000 as of September 30, 2007) plus
25 percent of all consideration received from issuing equity securities and subordinated debt and
25 percent of positive consolidated net income in each quarter.
We were not in compliance with the minimum tangible net worth covenant for the months
September 2006 to November 2006. On December 22, 2006, we signed an amendment to the agreement
governing the credit facility. Among other things, the amendment (i) modified the borrowing base to
increase the eligible accounts receivable from 80 percent to 85 percent and modified the definition
of accounts that are ineligible under the borrowing base calculation; (ii) modified the loan margin
as defined to 1.50 percent; and (iii) waived non-compliance with the minimum tangible net worth
requirement at September 30, 2006, October 31, 2006 and November 30, 2006, and modified the terms
of the covenant. On February 23, 2007, the credit agreement was amended to further modify the
minimum tangible net worth provision and to extend the maturity date to February 27, 2008. As of
December 31, 2006 and September 30, 2007, we were in compliance with all covenants. During
February through May 2007, the outstanding advances exceeded 50 percent of the receivable borrowing
base referred to above. As required by the agreement our lock-box proceeds were applied daily to
reduce the outstanding advances and we re-borrowed the amount subject to the lenders approval. The
daily borrowings and repayments have been presented on a net basis in the condensed consolidated
statements of cash flows. In June 2007, outstanding advances were reduced to less than 50 percent
of the receivable borrowing base, and we were no longer required to repay and re-borrow funds on a
daily basis as of July 13, 2007.
7. Capital Stock and Net Loss Per Share
Basic net loss per share is computed by dividing net loss by the weighted average number of
common shares outstanding for the respective periods. Diluted loss per share, calculated using the
treasury stock method, gives effect to the potential dilution that could occur upon the exercise of
certain stock options and warrants that were outstanding during the respective periods presented.
For periods when we reported a net loss, these potentially dilutive common shares were excluded
from the diluted loss per share calculation because they were anti-dilutive.
8. Stock-Based Compensation
Our equity incentive programs include stock options, restricted stock units and deferred stock
units. Some awards vest based on continuous service while others vest or accelerate-vest based on
performance conditions, such as profitability and sales goals. On January 1, 2006, we adopted SFAS
No. 123 (revised), Share-Based Payment (SFAS No. 123R), which requires measurement and recognition
of compensation expense for all share-based awards made to employees and directors.
Under SFAS No. 123R, the fair value of share-based awards is estimated at grant date using an
option pricing model, and the portion that is ultimately expected to vest is recognized as
compensation cost over the requisite service period. For awards that vest based on service, we
record compensation expense ratably over the service period from the date of grant. For
performance-based awards, we begin recording compensation expense over the remaining service period
when we determine that achievement is probable. Change in estimates as to the probability of
vesting is recorded through cumulative catch-up adjustments when the assessment is made. Since
share-based compensation under SFAS No. 123R is recognized only for those awards that are
ultimately expected to vest, we have applied an estimated forfeiture rate to unvested awards for
the purpose of calculating compensation cost. These estimates will be revised, if necessary, in
future periods if actual forfeitures differ from the estimates. Changes in forfeiture estimates
impact compensation cost in the period in which the change in estimate occurs. We use the
Black-Scholes option-pricing model to estimate the fair value of share-based awards. The
determination of fair value using the Black-Scholes option-pricing model is affected by our stock
price as well as assumptions regarding a number of complex and subjective variables, including
expected stock price volatility, risk-free interest rate, expected dividends and projected employee
stock option exercise behaviors.
During the third quarter of 2007, the Company determined that it is probable the profitability
goals will be met by the first quarter of 2009 and that the related performance-based awards will
vest. In conjunction with this change in assessment, the Company recorded $0.5 million of
compensation expense in the third quarter, including a cumulative adjustment for expenses relating
to the second quarter of 2007 as if the probable assessment had been determined at the original
grant date.
12
Total stock-based compensation expense recorded in the three and nine-months ended September
30, 2007 is $1.4 million and $2.9 million, respectively. Total stock-based compensation expense
recorded in the three and nine-months ended September 30, 2006 is $0.1 million and $2.0 million,
respectively. These amounts are primarily included in selling and marketing and general and
administrative expenses.
9. Inventories
Inventories, consisting of raw materials, work-in-process and finished goods, are stated at
the lower of cost or market, with cost determined by the first-in, first-out method. Reserves for
slow-moving and obsolete inventories are provided based on historical experience and product
demand. We evaluate the adequacy of these reserves periodically.
The following is a summary of inventories (excluding assets of discontinued operations):
|
|
|
|
|
|
|
|
|
|
|
September 30, |
|
|
December 31, |
|
|
|
2007 |
|
|
2006 |
|
Raw materials |
|
$ |
1,899 |
|
|
$ |
1,750 |
|
Work in process |
|
|
426 |
|
|
|
300 |
|
Finished goods |
|
|
849 |
|
|
|
778 |
|
|
|
|
|
|
|
|
Total inventories |
|
|
3,174 |
|
|
|
2,828 |
|
Less: inventory reserve |
|
|
(472 |
) |
|
|
(568 |
) |
|
|
|
|
|
|
|
Inventories, net |
|
$ |
2,702 |
|
|
$ |
2,260 |
|
|
|
|
|
|
|
|
10. Commitments and Contingencies
Legal Proceedings
Governmental Investigations and Legal Proceedings
As reported in the Form 8-K that we filed on July 20, 2006, we executed a consent to entry of
judgment in favor of the SEC on July 14, 2006 and entered into a non-prosecution agreement with the
DOJ on July 18, 2006. These two agreements effectively resolve with respect to us the
investigations begun by the SEC and by the DOJ in January 2003, regarding allegations that we and
certain of our former officers and former directors and one current employee issued, or caused to
be issued, false and misleading statements regarding our financial results for 2001 and 2002 and
related matters. Under the terms of the consent judgment with the SEC: (i) we paid $750,000 in
civil penalties and disgorgement; and (2) we agreed to a stipulated judgment enjoining future
violations of securities laws. On April 7, 2006, we entered into an escrow agreement with our
outside counsel, pursuant to which we placed the $750,000 anticipated settlement in escrow with our
outside counsel at the request of the SEC staff. The funds were released from the escrow to the
SEC in August 2006. A liability for the monetary penalty was accrued in 2004.
The investigations and legal proceedings related to certain former officers and former
directors remain ongoing and are not affected by our settlements with the SEC and DOJ. We remain
contractually obligated to pay legal fees for and otherwise indemnify these former officers and
former directors. On August 9, 2006 the SEC filed civil fraud charges in federal district court
against two former officers. On April 9, 2007, these two former officers were indicted by a
federal grand jury in Orange County, California. Our directors and officers liability insurance
has funded certain losses, including defense costs, related to these matters. As of September 30,
2007, we had $0.2 million in remaining available coverage under the applicable excess directors and
officers liability policy. This policy reimburses 75 percent of the first $2.25 million in
eligible costs to a maximum of approximately $1.7 million, zero percent of the next $500,000 and
57.5 percent of the next $1 million to a maximum of $0.6 million. For further information regarding
this coverage, please refer to the Form 8-K that we filed on February 25, 2005.
13
Lawsuit with KPMG LLP
On October 26, 2006, we filed a lawsuit with the Superior Court of the State of California for
the County of Orange against our former independent auditor, KPMG LLP, for professional negligence
and breach of contract, seeking damages in an amount to be determined at trial. In response to our
claims against KPMG, KPMG filed a cross-complaint against us and certain former officers.
On September 11, 2007, we entered into a binding memorandum of understanding (MOU) with KPMG.
The MOU resolves the litigation with KPMG. Under the MOU the parties have granted mutual releases
and agreed to dismiss our respective claims in the litigation. In addition, KPMG agreed that no
later than October 11, 2007 KPMG would pay to us a settlement
amount of $1.0 million and would return
to us fees in the amount of $0.2 million. KPMG made this payment and return of fees on October 11,
2007. Under a preexisting contingency fee agreement, we are required to pay one-third of the
settlement amount and one-third of the returned fees to our outside litigation counsel. The net
recovery of $0.7 million was recorded as a litigation settlement receivable as of September 30, 2007.
Other Litigation
In January 2006, we entered into a settlement and release agreement with certain parties
against whom we had a claim from a judgment awarded to us in prior
years. We received $0.2 million in
the settlement of this claim, which was recorded as a reduction of general and administrative
expenses in the first quarter of 2006.
In addition, in the normal course of business, we are subject to various other legal matters,
which we believe will not individually or collectively have a material adverse effect on our
consolidated financial condition, results of operations or cash flows. However, the results of
litigation and claims cannot be predicted with certainty, and we cannot provide assurance that the
outcome of various legal matters will not have a material adverse effect on our consolidated
financial condition, results of operations or cash flows. As of September 30, 2007, we have not
established a liability for contingencies in the consolidated balance sheets since the likelihood
of loss and potential liability cannot be reliably estimated at this time. However, our evaluation
of the likelihood of an unfavorable outcome with respect to these actions could change in the
future.
11. Income Taxes
On January 1, 2007, we adopted Financial Accounting Standards Board (FASB) Interpretation No.
48, Accounting for Uncertainty in Income Taxes, an interpretation of SFAS No. 109, Accounting for
Income Taxes (FIN 48). FIN 48 creates a single model to address accounting for uncertainty in tax
positions. It clarifies the accounting for income taxes, by prescribing a minimum recognition
threshold a tax position is required to meet before being recognized in the financial statements.
FIN 48 also provides guidance on derecognition, measurement, classification, interest and
penalties, accounting in interim periods, disclosure and transition.
As of the
adoption date, we had $0.2 million of unrecognized tax benefits, all of which would
affect our effective tax rate if recognized. A reconciliation of the beginning and ending amount of
unrecognized tax benefit is as follows:
|
|
|
|
|
Balance as of January 1, 2007 |
|
$ |
240,000 |
|
Additions based on tax positions related to the current year |
|
|
|
|
Additions for tax positions of prior years |
|
|
|
|
Reductions for tax positions of prior years |
|
|
|
|
Settlements |
|
|
|
|
|
|
|
|
Balance as of September 30, 2007 |
|
$ |
240,000 |
|
|
|
|
|
Because of our historical losses, FIN 48 did not have an effect on our accounting and disclosure
for income taxes. We do not anticipate that there will be a material change in the balance of the
unrecognized tax benefits within the next twelve months. We recognize interest and penalties
related to uncertain tax positions in income tax expense. We have approximately $40,000 of accrued
interest related to uncertain tax positions as of January 1, 2007 and September 30, 2007. The tax
years 2003 through 2006 remain open to examination by the major taxing jurisdictions to which we
are subject.
14
We reported no net income tax expense from continuing and discontinued operations during the
three and nine months ended September 30, 2007 and 2006 due to our operating losses. The 2006 tax
benefit on continuing operations of $0.2 million is the result of the 2006 first quarter pre-tax
book losses being utilized against pre-tax book income from discontinued operations. There is an
offsetting tax provision within discontinued operations. Due to our history of operating losses,
management has determined that it is more likely than not that our deferred tax assets will not be
realized through future earnings. Accordingly, valuation allowances were recorded to fully reserve
the deferred tax assets as of September 30, 2007 and December 31, 2006.
12. Results of Operations
Revenues and cost of revenues from continuing operations related to the following products and
services for the periods ended September 30, 2007 and 2006 are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Nine Months Ended |
|
|
|
September 30, |
|
|
September 30, |
|
|
|
2007 |
|
|
2006 |
|
|
2007 |
|
|
2006 |
|
Revenues: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cryoablation disposable products |
|
$ |
5,312 |
|
|
$ |
3,460 |
|
|
$ |
15,932 |
|
|
$ |
9,061 |
|
Cryocare Surgical Systems |
|
|
385 |
|
|
|
423 |
|
|
|
1,383 |
|
|
|
814 |
|
Other |
|
|
2 |
|
|
|
156 |
|
|
|
151 |
|
|
|
566 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
5,699 |
|
|
|
4,039 |
|
|
|
17,466 |
|
|
|
10,441 |
|
Cryoablation procedure fees |
|
|
1,541 |
|
|
|
2,492 |
|
|
|
5,029 |
|
|
|
9,963 |
|
Cardiac royalties (CryoCath) |
|
|
86 |
|
|
|
169 |
|
|
|
278 |
|
|
|
466 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
7,326 |
|
|
$ |
6,700 |
|
|
$ |
22,773 |
|
|
$ |
20,870 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Costs of Revenues: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cryoablation disposable products and procedure fees |
|
$ |
2,057 |
|
|
$ |
2,636 |
|
|
$ |
6,803 |
|
|
$ |
9,060 |
|
Cryocare Surgical Systems |
|
|
114 |
|
|
|
41 |
|
|
|
703 |
|
|
|
639 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
2,171 |
|
|
$ |
2,677 |
|
|
$ |
7,506 |
|
|
$ |
9,699 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of revenues for cryoablation disposable product sales and procedure fees are combined for
reporting purposes. Sales of cryoablation disposable products and procedure fees both incorporate
similar inventory when sold and we do not separately track the cost of disposals sold directly to
customers and those consumed in cryoablation procedures. Cryoablation procedure services are
provided to medical facilities upon request to facilitate the overall delivery of our technology
into the marketplace.
13. Recent Accounting Pronouncements
Other recent accounting pronouncements issued by the FASB (including its Emerging Issues Task
Force), the American Institute of Certified Public Accountants and the SEC did not, or are not
believed by management to, have a material impact on our present or future consolidated financial
statements.
14. Reclassification
Certain 2006 amounts in the statements of cash flows have been reclassified to conform to 2007
presentation with respect to changes in operating assets and liabilities due to the sale of
placement units and extinguishment of payroll tax liabilities.
Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis should be read in conjunction with the unaudited
condensed consolidated financial statements and notes thereto included in Part I Item 1 of this
report, and the audited consolidated financial statements and notes thereto, and Managements
Discussion and Analysis of Financial Condition and Results of Operations contained in the Annual
Report on Form 10-K for the fiscal year ended December 31, 2006.
This discussion contains forward-looking statements based on our current expectations. There
are various factors many beyond our control that could cause our actual results or the
occurrence or timing of expected events to differ materially from those anticipated in these
forward-looking statements. Some of these factors are described below and other factors are
described elsewhere in this Quarterly Report on Form 10-Q or under Risk Factors in
15
our Annual Report on Form 10-K referred to above. In addition, there are factors not described
in this Quarterly Report on Form 10-Q or in our Annual Report on Form 10-K that could cause our
actual results or the occurrence or timing of expected events to differ materially from those
anticipated in these forward-looking statements. All forward-looking statements included in this
Quarterly Report on Form 10-Q are based on information available to us as of the date hereof, and
we assume no obligation to update any such forward-looking statements.
Overview
We are an innovative medical device company focused on the development of minimally invasive
technologies for tissue and tumor ablation through cryoablation, which is the use of lethal ice to
destroy tissue, such as tumors, for therapeutic purposes. We develop and manufacture devices for
the treatment of prostate and renal cancers and we believe that our proprietary technologies have
broad applications across a number of markets, including the ablation of tumors in the lung and
liver and palliative intervention (treatment of pain associated with metastases).
Today, our FDA-cleared Cryocare Surgical System occupies a growing position in the urological
market for treatment of prostate and renal cancers. Because of our initial concentration on
prostate and renal cancers, the majority of our sales and marketing resources is directed toward
the promotion of our technology to urologists. In addition to selling our cryosurgical disposable
products to hospitals and mobile service companies, we contract directly with hospitals for the use
of our Cryocare Surgical System and disposable products on a fee-for-service basis. Since 2003, we
also maintain a dedicated sales team focused on selling percutaneous cryoablation procedures
related to kidney, liver and lung cancer and palliative intervention to interventional radiology
physicians throughout the United States. We intend to continue to identify and develop new markets
for our cryosurgical products and technologies, particularly in the area of tumor ablation.
We previously owned Timm Medical Technologies, Inc. (Timm Medical), a company focused on
erectile dysfunction products. We sold Timm Medical to United Kingdom-based Plethora Solutions
Holdings plc effective on February 10, 2006.
Strategy, Key Metrics and Developments
Our primary objective is to grow market share, currently measured in terms of the estimated
number of procedures performed with our Cryocare Surgical System, which we calculate using two
primary components. The first component is the actual number of cryoablation cases for which we
provide the cryoablation products for a treatment and are also responsible for performing the
service element on behalf of the healthcare facility. Cryoablation services generally consist of
rental and transport of a Cryocare Surgical System as well as the service of a technician to assist
the physician with the setup and monitoring of the equipment. For the second component of the
calculation, we compute an estimated cryoablation case equivalent based on direct sales of our
cryoablation disposable products (instances in which we sell products separately without the
service element) by using the expected disposable product usage for those sales. Estimated
procedure growth has been an important metric to which we have referred during the past several
years in order to measure the success of our strategy.
In addition to being a key business metric, procedure growth has been an important driver of
revenue growth, because a significant percentage of our revenue consists of sales of the disposable
products used in procedures performed with the Cryocare Surgical System, as shown below under
Results of Operations. In 2003 we redirected our strategy for our cryoablation business away from
emphasizing sales of Cryocare Surgical Systems and instead toward seeking to increase sales of
cryoablation disposable products. Historically, we were responsible for performing the service
element of the procedure on behalf of the healthcare facility for the majority of our reported
procedures. Beginning in 2004, we changed our business model to emphasize our strength as a medical
device manufacturer and strategically reduced the amount of revenues attributable to the service
model where we are responsible for performing the service element of the procedures on behalf of
the healthcare facility for a procedure fee. By the fourth quarter of 2006, we had achieved our
goal of having the substantial majority of our procedures comprised of sales of cryoablation
disposable products without the service element. During 2006, we succeeded in causing the
percentage of total estimated domestic cryoablation procedures for which we perform the service
element to decline from 50 percent of total reported procedures for the three months ended March
31, 2006 to 20 percent of total reported procedures for the three months ended December 31, 2006.
During the three months ended
16
September 30, 2007, the percentage for which we performed the service element of the procedure
declined further to 13 percent of total reported procedures.
Given that we have accomplished the business model transition mentioned above, the majority of
our revenues are from sales of cryoablation disposable products and we will again be able to view
revenue growth as an important business metric going forward. One result of our new model is that
our customers hospitals and third-party service providers are now carrying inventories of our
probes and other equipment for use in performing cryoablation procedures. Because of the
variability of probe use across patients and applications, estimating accurately how many
procedures are performed based on sales of cryoablation disposable products is becoming more
difficult. Because we are less involved in providing the service element of the procedure, we also
will have less ability to ensure that we receive accurate case information in order to validate the
assumptions we use about how many cryoprobes are used in an average procedure. Accordingly, we
have decided that beginning with the fourth quarter of 2007 and going forward, in addition to
revenues, we will begin to provide alternative business metrics such as the number of cryoprobes
sold during the period. We believe that these measurements can provide more useful data to the
investment community and other users of our financial statements and will allow us to be more
precise with the data we provide.
For periods through the end of 2007, we will continue to report estimated procedure numbers
and the estimated growth rates of those procedures over prior periods.
The change in our business model and revenue mix discussed above also has impacted our gross
margin due to the disparity in per-procedure revenue between cases for which we are responsible for
providing the service element and cases for which we merely sell disposable products. This
disparity results from the fact that the revenue from a case for which we merely sell disposable
products is less than the revenue from a case for which we are also responsible for providing the
service element (referred to as procedure fees below). As the percentage of cases for which we
merely sell disposable products increases relative to cases for which we are responsible for
providing the service element, our incremental revenues grow at a slower rate than our overall
procedure growth. However, the gross profit realized is generally equivalent since we do not incur
fees to third party subcontractors for cases for which we merely sell disposable products. In
contrast, in cases for which we are responsible for providing the service element, we typically
subcontract with a third party service provider to provide the service element on our behalf and
thereby incur service fees. As a result, our gross margin (gross profit as a percent of revenues)
increases as we shift from procedure fees to sales of disposable products.
In the past several years, we have been successful in increasing the estimated number of
domestic cryoablation procedures on a year-over-year basis. In 2005 total estimated procedures
increased 36 percent to 6,407 from 4,713 in 2004. In 2006 total estimated procedures increased 22
percent to 7,802. During the three months ended September 30, 2007, total estimated procedures
increased 25 percent to 2,353 from 1,883 in the three months ended September 30, 2006. During the
nine months ended September 30, 2007, total estimated procedures increased 27 percent to 7,104 from
5,582 in the prior year period.
The factors driving interest in and utilization of cryoablation by urologists include
increased awareness and acceptance of cryoablation by physicians and industry thought leaders,
continued publication of clinical follow up data on the effectiveness of cryoablation, increased
awareness among patients of cryoablation and its preferred outcomes as compared to other
modalities, the efforts of our dedicated cryoablation sales force and our continued expenditure of
funds on physician training as well as patient education and advocacy.
We believe that one of the factors that adversely impacts procedure growth and revenues is
that certain urologists decide from time to time to try new techniques for the treatment of
prostate cancer. We cannot predict the extent to which this factor may continue to affect us.
However, the prostate cancer treatment market is very competitive and there are many different
treatment options that have been developed and that are continuing to be developed.
17
Results of Operations
Revenues and costs of revenues from continuing operations related to the following products
and services for the three and nine months ended September 30, 2007 and 2006 are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Nine Months Ended |
|
|
|
September 30, |
|
|
September 30, |
|
|
|
2007 |
|
|
2006 |
|
|
2007 |
|
|
2006 |
|
Revenues: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cryoablation disposable products |
|
$ |
5,312 |
|
|
$ |
3,460 |
|
|
$ |
15,932 |
|
|
$ |
9,061 |
|
Cryocare Surgical Systems |
|
|
385 |
|
|
|
423 |
|
|
|
1,383 |
|
|
|
814 |
|
Other |
|
|
2 |
|
|
|
156 |
|
|
|
151 |
|
|
|
566 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
5,699 |
|
|
|
4,039 |
|
|
|
17,466 |
|
|
|
10,441 |
|
Cryoablation procedure fees |
|
|
1,541 |
|
|
|
2,492 |
|
|
|
5,029 |
|
|
|
9,963 |
|
Cardiac royalties (CryoCath) |
|
|
86 |
|
|
|
169 |
|
|
|
278 |
|
|
|
466 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
7,326 |
|
|
$ |
6,700 |
|
|
$ |
22,773 |
|
|
$ |
20,870 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Costs of Revenues: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cryoablation disposable products and procedure fees |
|
$ |
2,057 |
|
|
$ |
2,636 |
|
|
$ |
6,803 |
|
|
$ |
9,060 |
|
Cryocare Surgical Systems |
|
|
114 |
|
|
|
41 |
|
|
|
703 |
|
|
|
639 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
2,171 |
|
|
$ |
2,677 |
|
|
$ |
7,506 |
|
|
$ |
9,699 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Costs of revenues for cryoablation disposable products and procedure fees are combined for
reporting purposes. Sales of cryoablation disposable products and procedure fees incorporate
similar inventory when sold and we do not separately track the cost of disposable products sold
directly to customers and those consumed in cryoablation procedures.
We recognize revenues from sales of Cryocare Surgical Systems and disposable cryoprobes when
persuasive evidence of an arrangement exists, delivery has occurred, the fee is fixed and
determinable and collectibility is reasonably assured. Per-procedure fees are recorded when the
service has been rendered.
Costs of revenues consist of fixed and variable costs incurred in the manufacture of our
products in addition to depreciation of Cryocare Surgical Systems placed in the field with
customers under our placement program or with our sales and service personnel. We incur an
additional cost of revenues in the form of a fee for equipment usage and other services when a
procedure is performed on a system owned by an unrelated service provider. The fee paid to the
third-party service provider is charged to costs of revenues when the procedure is performed and
billed.
Research and development expenses include expenses associated with the design and development
of new products as well as enhancements to existing products. We expense research and development
costs when incurred. Our research and development efforts are occasionally subject to significant
non-recurring expenses and fees that can cause some variability in our quarterly research and
development expenses.
Selling and marketing expenses primarily consist of salaries, commissions and related benefits
and overhead costs for employees and activities in the areas of selling, marketing and customer
service. Expenses associated with advertising, trade shows, promotional and physician training
costs related to marketing our products are also classified as selling and marketing expenses.
General and administrative expenses primarily consist of salaries and related benefits and
overhead costs for employees and activities in the areas of legal affairs, finance, information
technology, human resources and administration. Fees for attorneys, independent auditors and
certain other outside consultants are also included where their services are related to general and
administrative activities. This category also includes reserves for bad debt and litigation losses
less amounts recoverable under our insurance policies. Litigation reserves and insurance recoveries
are recorded when such amounts are probable and can be reasonably estimated.
Effective January 1, 2006, we adopted Statement of Financial Accounting Standards No. 123 (revised
2004), Share Based Payment (SFAS No. 123R) using the modified-prospective transition method. Under
that transition method, compensation cost recognized in the nine months ended September 30, 2007
and 2006 included (a) compensation cost for all share-based payments granted prior to, but not yet
vested as of January 1, 2006 based on the grant date fair value estimated in accordance with the
original provisions of SFAS 123 and (b) compensation cost for all share-based payments granted
subsequent to January 1, 2006, based on the grant date fair value estimate in accordance with the
provisions of SFAS 123R. As of September 30, 2007, there was $2.2 million of total unrecognized
compensation costs related to stock options and $2.3 million related to restricted stock units. The
stock-option compensation cost is amortized on a straight-line basis over a weighted average period
of 1.06 years less any stock options forfeited prior to vesting. Compensation costs related to
restricted stock units is recorded over the service
18
period (2007 through 2009) if it is probable the performance conditions (profitability and sales
goals) will be satisfied. Stock-based compensation expense recorded in the three and nine-months
ended September 30, 2007 is $1.4 million and $2.9 million, respectively. Stock-based compensation
expense recorded in the three and nine-months ended September 30, 2006 is $0.1 million and $2.0
million, respectively. In the three months ended September 30, 2007, we determined that the
profitability goals for certain performance based awards will likely be met and recorded $0.5
million in cumulative compensation expense for these awards. Of this total, $0.1 million was
recorded as selling and marketing expense and $0.4 million as general and administrative expenses.
Three Months Ended September 30, 2007 Compared to Three Months Ended September 30, 2006
Revenues
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
|
|
|
|
|
|
September 30, |
|
|
|
|
|
|
|
|
|
2007 |
|
|
2006 |
|
|
$ Change |
|
|
% Change |
|
(dollars in thousands) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cryoablation disposable products |
|
$ |
5,312 |
|
|
$ |
3,460 |
|
|
$ |
1,852 |
|
|
|
53.5 |
% |
Cryocare Surgical Systems |
|
|
385 |
|
|
|
423 |
|
|
|
(38 |
) |
|
|
(9.0 |
)% |
Other |
|
|
2 |
|
|
|
156 |
|
|
|
(154 |
) |
|
|
(98.7 |
)% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
5,699 |
|
|
|
4,039 |
|
|
|
1,660 |
|
|
|
41.1 |
% |
Cryoablation procedure fees |
|
|
1,541 |
|
|
|
2,492 |
|
|
|
(951 |
) |
|
|
(38.2 |
)% |
Cardiac royalties (CryoCath) |
|
|
86 |
|
|
|
169 |
|
|
|
(83 |
) |
|
|
(49.1 |
)% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
7,326 |
|
|
$ |
6,700 |
|
|
$ |
626 |
|
|
|
9.3 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Although our total number of estimated procedures increased approximately 25 percent to 2,353
from 1,883 for the three months ended September 30, 2007 compared to September 30, 2006, our
increase in revenue is not reflective of this increase because of our change in revenue mix.
Generally, we earn less revenue per estimated case for sales of cryoablation disposable products
than for procedure fees; however the related gross margin as a percent of revenues for sales of
cryoablation disposable products is greater. Of the total estimated procedures performed during
the three months ended September 30, 2007, 13 percent were those for which we provided cryoablation
services and 87 percent were from the sale of cryoablation disposable products. This compares to 27
percent for cryoablation services and 73 percent for sales of cryoablation disposable products
during the three months ended September 30, 2006.
Also contributing to growth in sales of cryoablation products was an increase in sales to a
market served by interventional radiologists, treating tumors in the kidney, lung and liver and
palliative intervention. Direct sales of disposable products and interventional radiology
procedures generally have a lower average selling price than procedures performed by urologists on
prostate and renal treatments although costs of revenues are also lower.
Cardiac royalty revenues decreased for the three months ended September 30, 2007 over the same
period in 2006. The contractual rate of royalties CryoCath is obligated to pay us as a percentage
of related revenues decreased from 5.0 percent in 2006 to 3.0 percent in 2007.
Cost of Revenues
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
|
September 30, |
|
|
|
|
2007 |
|
2006 |
|
$ Change |
(dollars in thousands) |
|
|
|
|
|
|
|
|
|
|
|
|
Three months ended |
|
$ |
2,171 |
|
|
$ |
2,677 |
|
|
$ |
(506 |
) |
Percent of revenues |
|
|
29.6 |
% |
|
|
40.0 |
% |
|
|
|
|
The decrease in cost of revenues resulted primarily from the change in the mix of our revenues
from those where we are responsible for providing cryoablation procedure services to solely selling
cryoablation disposable products. This mix shift led to a decrease in the number of cases for which
we paid fees to third party service providers. In addition, costs of revenues declined due to
decreases in materials, labor and overhead costs. During the three
19
months ended September 30, 2007 and 2006, substantially all of our cryoablation procedures for
which we were responsible for the service element were performed by third party service providers
at an additional cost to us.
Gross Profit and Gross Margin
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
|
|
|
September 30, |
|
|
|
|
|
|
2007 |
|
|
2006 |
|
|
$ Change |
|
(dollars in thousands) |
|
|
|
|
|
|
|
|
|
|
|
|
Cryoablation disposable products and procedure fees |
|
$ |
4,796 |
|
|
$ |
3,316 |
|
|
$ |
1,480 |
|
Cryocare surgical systems |
|
|
271 |
|
|
|
382 |
|
|
|
(111 |
) |
Cardiac royalties (CryoCath) and other |
|
|
88 |
|
|
|
325 |
|
|
|
(237 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
$ |
5,155 |
|
|
$ |
4,023 |
|
|
$ |
1,132 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
Percentage |
|
|
September 30, |
|
Point |
|
|
2007 |
|
2006 |
|
Change |
(percent of revenues) |
|
|
|
|
|
|
|
|
|
|
|
|
Cryoablation disposable products and procedure fees |
|
|
65.5 |
% |
|
|
49.5 |
% |
|
|
16.0 |
% |
Cryocare Surgical Systems |
|
|
3.7 |
% |
|
|
5.7 |
% |
|
|
(2.0 |
)% |
Cardiac royalties (CryoCath) |
|
|
1.2 |
% |
|
|
4.8 |
% |
|
|
(3.6 |
)% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
70.4 |
% |
|
|
60.0 |
% |
|
|
10.4 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
The positive trend in gross margins (gross profit as a percentage of revenues) was primarily
related to our shift from procedures where we bear responsibility for the service element of the
procedure to those where we solely sell our cryoablation disposable products. Sales of
cryoablation disposable products yield a higher gross margin than procedures performed by third
party subcontractors. We also have continued to reduce manufacturing costs for our cryoablation
disposable products, while increasing efficiencies in production.
Research and Development Expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
|
|
|
September 30, |
|
|
|
|
|
|
2007 |
|
2006 |
|
$ Change |
|
% Change |
(dollars in thousands) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Research and development expenses |
|
$ |
699 |
|
|
$ |
581 |
|
|
$ |
118 |
|
|
|
20.3 |
% |
Percent of total revenues |
|
|
9.5 |
% |
|
|
8.7 |
% |
|
|
|
|
|
|
|
|
This increase is primarily attributable to expenses related to clinical studies, which are
generally recognized in conjunction with milestones inherent in the studies and enrollment of
patients, and as such are not always predictable in amount and timing. In 2007, we are focusing our
research dollars on those areas in which cryoablation research is required to substantiate
reimbursement codes and coverage. The 2007 increase in clinical studies expense was partially
offset by a reduction in consulting costs, engineering supplies and stock-based compensation.
Selling and Marketing Expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
|
|
|
September 30, |
|
|
|
|
|
|
2007 |
|
2006 |
|
$ Change |
|
% Change |
(dollars in thousands) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling and marketing expenses |
|
$ |
3,500 |
|
|
$ |
3,725 |
|
|
$ |
(225 |
) |
|
|
(6.0 |
)% |
Percent of total revenues |
|
|
47.8 |
% |
|
|
55.6 |
% |
|
|
|
|
|
|
|
|
20
Our efforts to reduce costs have been effective resulting in reductions in travel and
entertainment costs, consulting costs and advertising, trade shows and related expenses totaling
$0.5 million for the three months ended September 30, 2007. However, due mainly to the increased
revenues in the current quarter over the same period last year, our cash compensation related costs
increased $0.2 million. Included in selling and marketing expenses for the three months ended
September 30, 2007 were $0.3 million in non-cash stock-based compensation expenses. There were no
such expenses during the three months ended September 30, 2006.
General and Administrative Expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
|
|
|
September 30, |
|
|
|
|
|
|
2007 |
|
2006 |
|
$ Change |
|
% Change |
(dollars in thousands) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
General and administrative expenses |
|
$ |
2,881 |
|
|
$ |
3,196 |
|
|
$ |
(315 |
) |
|
|
(9.9 |
)% |
Percent of total revenues |
|
|
39.3 |
% |
|
|
47.7 |
% |
|
|
|
|
|
|
|
|
This decrease is due in part to the reversal of the $0.3 million reserve on the note
receivable from Plethora in relation to the sale of Timm Medical. In the fourth quarter of 2006,
we had been in discussions with Plethora to potentially accelerate the payment of the note for a
lump sum discounted amount. Based on these discussions we reserved $0.3 million of the note.
Since that time, our discussions have ceased and we believe that it is unlikely that we would
accept a discounted payment amount on the note. As a result, during the three months ended
September 30, 2007, we eliminated the reserve and reinstated the note to its face value. Legal
fees decreased during the three months ended September 30, 2007 by $0.2 million mainly due to
reduced legal fees generated by law firms representing the former officers and former directors in
connection with ongoing SEC and DOJ matters. Other expense decreased $0.4 million and included
reductions in professional services, compensation costs and travel and related expenses. In
addition, we recently resolved past due state and local tax matters in several jurisdictions,
resulting in a reduction of our tax liability of $0.1 million. Partially offsetting these decreases
was an increase of $0.9 million of non-cash stock-based
compensation expense, of which $0.4 million
related to a catch-up adjustment for performance-based restricted stock units for which we
determined the achievement of the performance goals is probable. Total stock-based compensation
expense for each of the three months ended September 30, 2007 and September 30, 2006 was $1.0
million and $0.1 million, respectively.
Litigation Settlement, Net of Related Legal Expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
|
|
|
September 30, |
|
|
|
|
|
|
2007 |
|
2006 |
|
$ Change |
|
% Change |
(dollars in thousands) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Litigation settlement, net |
|
$ |
(677 |
) |
|
$ |
|
|
|
$ |
(677 |
) |
|
|
100 |
% |
Percent of total revenues |
|
|
(9.2 |
)% |
|
|
|
|
|
|
|
|
|
|
|
|
The quarter ended September 30, 2007 includes $0.7 million for litigation settlement, net of
related legal expenses. This amount relates to our settlement with KPMG LLP described below in
Part II, Item 1, Legal Proceedings.
Interest Expense Related to Common Stock Warrants
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
|
|
|
September 30, |
|
|
|
|
|
|
2007 |
|
2006 |
|
$ Change |
|
% Change |
(dollars in thousands) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest expense related
to common stock warrants |
|
$ |
|
|
|
$ |
(1,245 |
) |
|
$ |
1,245 |
|
|
|
(100 |
)% |
Percent of total revenues |
|
|
|
|
|
|
(18.6 |
)% |
|
|
|
|
|
|
|
|
For the quarter ended September 30, 2006, the negative interest expense on common stock
warrants resulted from a decrease in the fair value of common stock warrants issued in connection
with our March 2005 private placement. As a result of a provision for liquidated damages under a
related registration rights agreement, these warrants were
21
accounted for as derivatives through December 31, 2006 and were carried at fair value with
changes in fair value recorded through interest expense. Effective January 1, 2007, we adopted FASB
Staff Position (FSP) No. 00-19-02, Accounting for Registration Payment Arrangements, which no
longer requires the warrants to be recorded as derivatives and no interest expense was recorded for
these warrants during the three months ended September 30, 2007. See Note 5 Private Placement of
Common Stock and Warrants for further discussion.
Interest Income, Net
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
|
|
|
September 30, |
|
|
|
|
|
|
2007 |
|
2006 |
|
$ Change |
|
% Change |
(dollars in thousands) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest income, net |
|
$ |
264 |
|
|
$ |
85 |
|
|
$ |
179 |
|
|
|
210.6 |
% |
Percent of total revenues |
|
|
3.6 |
% |
|
|
1.3 |
% |
|
|
|
|
|
|
|
|
Interest income, net in the 2007 and 2006 periods includes interest income on a note
receivable from the 2003 sale of our urinary incontinence product line and interest income earned
from the investment of our cash balances. Interest income in 2007 also includes interest income
previously suspended in the amount of $0.1 million related to a note receivable from the 2006 sale
of Timm Medical.
Net Loss
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
|
|
|
September 30, |
|
|
|
|
|
|
2007 |
|
2006 |
|
$ Change |
|
% Change |
(dollars in thousands) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss |
|
$ |
(984 |
) |
|
$ |
(2,149 |
) |
|
$ |
(1,165 |
) |
|
|
(54.2 |
)% |
Percent of total revenues |
|
|
(13.4 |
)% |
|
|
(32.1 |
)% |
|
|
|
|
|
|
|
|
Net loss for the three months ended September 30, 2007 was $0.08 per basic and diluted share
on 11.6 million weighted average shares outstanding, compared to a net loss of $0.21 per basic and
diluted share on 10.1 million weighted average shares outstanding during the same period in 2006.
Nine Months Ended September 30, 2007 Compared to Nine Months Ended September 30, 2006
Revenues
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended |
|
|
|
|
|
|
|
|
|
September 30, |
|
|
|
|
|
|
|
|
|
2007 |
|
|
2006 |
|
|
$ Change |
|
|
% Change |
|
(dollars in thousands) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cryoablation disposable products |
|
$ |
15,932 |
|
|
$ |
9,061 |
|
|
$ |
6,871 |
|
|
|
75.8 |
% |
Cryocare Surgical Systems |
|
|
1,383 |
|
|
|
814 |
|
|
|
569 |
|
|
|
69.9 |
% |
Other |
|
|
151 |
|
|
|
566 |
|
|
|
(415 |
) |
|
|
(73.3 |
)% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
17,466 |
|
|
|
10,441 |
|
|
|
7,025 |
|
|
|
67.3 |
% |
Cryoablation procedure fees |
|
|
5,029 |
|
|
|
9,963 |
|
|
|
(4,934 |
) |
|
|
(49.5 |
)% |
Cardiac royalties (CryoCath) |
|
|
278 |
|
|
|
466 |
|
|
|
(188 |
) |
|
|
(40.3 |
)% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
22,773 |
|
|
$ |
20,870 |
|
|
$ |
1,903 |
|
|
|
9.1 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Although our total number of estimated procedures increased approximately 27 percent to 7,104
from 5,582 for the nine months ended September 30, 2007 compared to September 30, 2006, our
increase in revenue is not reflective of this increase because of our change in revenue mix.
Generally, we earn less revenue per estimated case for sales of cryoablation disposable products
than for procedure fees; however the related gross margin as a percent of revenues for sales of
cryoablation disposable products is greater. Of the total estimated procedures performed during
the nine months ended September 30, 2007, 14 percent were those for which we provided cryoablation
services and 86 percent were from the sale of cryoablation disposable products. This compares to 36
percent for
22
cryoablation services and 64 percent for sales of cryoablation disposable products during the
nine months ended September 30, 2006.
Also contributing to growth in sales of cryoablation products was an increase in sales to a
market served by interventional radiologists, treating tumors in the kidney, lung and liver and
palliative intervention. Direct sales of disposable products and interventional radiology
procedures generally have a lower average selling price than procedures performed by urologists on
prostate and renal treatments although costs of revenues are also lower.
Cardiac royalty revenues decreased for the nine months ended September 30, 2007 over the same
period in 2006. The contractual rate of royalties CryoCath is obligated to pay us as a percentage
of related revenues decreased from 5.0 percent in 2006 to 3.0 percent in 2007.
Revenues from sales of Cryocare Surgical Systems increased as a result of a greater number of
systems sold.
Cost of Revenues
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended |
|
|
|
|
September 30, |
|
|
|
|
2007 |
|
2006 |
|
$ Change |
(dollars in thousands) |
|
|
|
|
|
|
|
|
|
|
|
|
Nine months ended |
|
$ |
7,506 |
|
|
$ |
9,699 |
|
|
$ |
(2,193 |
) |
Percent of revenues |
|
|
33.0 |
% |
|
|
46.5 |
% |
|
|
|
|
The decrease in cost of revenues resulted primarily from the change in the mix of our revenues
from those where we are responsible for providing cryoablation procedure services to solely selling
cryoablation disposable products. This mix shift led to a decrease in the number of cases for which
we paid fees to third party service providers. In addition, costs of revenues declined due to
decreases in materials, labor and overhead costs. During the nine months ended September 30, 2007
and 2006, substantially all of our cryoablation procedures for which we were responsible for the
service element were performed by third party service providers at an additional cost to us.
Gross Profit and Gross Margin
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended |
|
|
|
|
|
|
September 30, |
|
|
|
|
|
|
2007 |
|
|
2006 |
|
|
$ Change |
|
(dollars in thousands) |
|
|
|
|
|
|
|
|
|
|
|
|
Cryoablation disposable products and procedure fees |
|
$ |
14,158 |
|
|
$ |
9,964 |
|
|
$ |
4,194 |
|
Cryocare surgical systems |
|
|
680 |
|
|
|
175 |
|
|
|
505 |
|
Cardiac royalties (CryoCath) and other |
|
|
429 |
|
|
|
1,032 |
|
|
|
(603 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
$ |
15,267 |
|
|
$ |
11,171 |
|
|
$ |
4,096 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended |
|
Percentage |
|
|
September 30, |
|
Point |
|
|
2007 |
|
2006 |
|
Change |
(percent of revenues) |
|
|
|
|
|
|
|
|
|
|
|
|
Cryoablation disposable products and procedure fees |
|
|
62.2 |
% |
|
|
47.7 |
% |
|
|
14.5 |
% |
Cryocare surgical systems |
|
|
3.0 |
% |
|
|
0.8 |
% |
|
|
2.2 |
% |
Cardiac royalties (CryoCath) and other |
|
|
1.9 |
% |
|
|
5.0 |
% |
|
|
(3.1 |
)% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
67.1 |
% |
|
|
53.5 |
% |
|
|
13.6 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
The positive trend in gross margins (gross profit as a percentage of revenues) was primarily
related to our shift from procedures where we bear responsibility for the service element of the
procedure to those where we solely sell our cryoablation disposable products. Sales of
cryoablation disposable products yield a higher gross margin than
23
procedures performed by third party subcontractors. We also have continued to reduce
manufacturing costs for our cryoablation disposable products, while increasing efficiencies in
production.
Research and Development Expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended |
|
|
|
|
|
|
September 30, |
|
|
|
|
|
|
2007 |
|
2006 |
|
$ Change |
|
% Change |
(dollars in thousands) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Research and development expenses |
|
$ |
1,935 |
|
|
$ |
2,067 |
|
|
$ |
(114 |
) |
|
|
(5.5 |
)% |
Percent of total revenues |
|
|
8.6 |
% |
|
|
9.9 |
% |
|
|
|
|
|
|
|
|
This decrease is primarily attributable to a $0.1 million reduction in educational grants and
clinical studies expenses. In 2007, we are focusing our research dollars on those areas in which
cryoablation research is required to substantiate reimbursement codes and coverage. In addition,
these expenses are generally recognized in conjunction with milestones inherent in the studies and
as such are not always predictable in amount and timing. Also contributing to the decrease is a
reduction in consulting costs, engineering supplies and stock-based compensation.
Selling and Marketing Expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended |
|
|
|
|
|
|
September 30, |
|
|
|
|
|
|
2007 |
|
2006 |
|
$ Change |
|
% Change |
(dollars in thousands) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling and marketing expenses |
|
$ |
11,362 |
|
|
$ |
11,398 |
|
|
$ |
(36 |
) |
|
|
(0.3 |
)% |
Percent of total revenues |
|
|
49.9 |
% |
|
|
54.6 |
% |
|
|
|
|
|
|
|
|
The
decrease is due mainly to the increased revenues in the current nine month period over the same period
last year, compensation and related costs for sales personnel increased $1.1 million. These
increases were offset by reductions in travel and entertainment costs, public relations expenses,
consulting costs and advertising, trade shows and related expenses totaling $1.1 million for the
nine months ended September 30, 2007. Included in selling and marketing expenses for the nine
months ended September 30, 2007 and 2006 were $0.5 million and $0.4 million in non-cash stock-based
compensation expense, respectively.
General and Administrative Expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended |
|
|
|
|
|
|
September 30, |
|
|
|
|
|
|
2007 |
|
2006 |
|
$ Change |
|
% Change |
(dollars in thousands) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
General and administrative expenses |
|
$ |
9,556 |
|
|
$ |
9,262 |
|
|
$ |
294 |
|
|
|
3.2 |
% |
Percent of total revenues |
|
|
42.0 |
% |
|
|
44.4 |
% |
|
|
|
|
|
|
|
|
This increase is due to increased legal fees generated by the law firms representing the
former officers and former directors in connection with the ongoing SEC and DOJ matters, as well as
legal action taken against KPMG as described in Note 10 Commitments and Contingencies. The
legal fees, net of insurance reimbursement, incurred during the nine months ended September 30,
2007 were $0.3 million greater than those incurred during the nine months ended September 30, 2006.
In addition, legal fees related to legal action against KPMG were $0.3 million during 2007.
Included in general and administrative expenses during the 2007 and 2006 period was a $0.1 million
and $0.9 million reduction in accrued payroll taxes pertaining to employee loans forgiven and stock
option exercises that occurred in 2002 and prior, which was no longer statutorily due. As a result
of our concerted effort to reduce costs, our audit, accounting, insurance, professional and
consulting fees decreased by over $1.0 million for the nine months ended September 30, 2007 as
compared to the same period in 2006. Expenses also decreased due to the reversal of the $0.3
million reserve on the note receivable from Plethora in relation to the sale of Timm Medical. In
the fourth quarter of 2006, we had been in discussions with Plethora to potentially accelerate the
payment of the note for a lump sum discounted amount. Based on these discussions we reserved $0.3
million of the note. Since that time, our discussions have ceased and we believe that it is
unlikely that we would accept a discounted payment
24
amount on the note. As a result, during the three months ended September 30, 2007, we
eliminated the reserve and reinstated the note receivable to its face value. Also offsetting the
increased legal and payroll tax expense is the recovery of previously unbilled sales and use taxes
from liable customers of $0.2 million, as well as the resolution of past due state and local tax
matters in several jurisdictions, resulting in a write down of our tax liability of $0.2 million.
Also included in general and administrative expenses for the nine months ended September 30, 2007
and September 30, 2006 were $2.3 million and $1.4 million of non-cash stock-based compensation
expense, respectively.
Litigation Settlement, Net of Related Legal Expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended |
|
|
|
|
|
|
September 30, |
|
|
|
|
|
|
2007 |
|
2006 |
|
$ Change |
|
% Change |
(dollars in thousands) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Litigation settlement, net |
|
$ |
(677 |
) |
|
$ |
|
|
|
$ |
(677 |
) |
|
|
100.0 |
% |
Percent of total revenues |
|
|
(3.0 |
)% |
|
|
|
|
|
|
|
|
|
|
|
|
The nine months ended September 30, 2007 include $0.7 million for litigation settlement, net
of related legal expenses. This amount relates to our settlement with KPMG LLP described below in
Part II, Item 1, Legal Proceedings.
Interest Expense Related to Common Stock Warrants
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended |
|
|
|
|
|
|
September 30, |
|
|
|
|
|
|
2007 |
|
2006 |
|
$ Change |
|
% Change |
(dollars in thousands) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest expense related to common stock warrants |
|
$ |
|
|
|
$ |
(2,941 |
) |
|
$ |
(2,941 |
) |
|
|
(100.0 |
)% |
Percent of total revenues |
|
|
|
|
|
|
(14.1 |
)% |
|
|
|
|
|
|
|
|
For the nine months ended September 30, 2006, the negative interest expense on common stock
warrants resulted from a decrease in the fair value of common stock warrants related to our March
2005 private placement. As a result of a provision for liquidated damages under a related
registration rights agreement, these warrants were accounted for as derivatives through December
31, 2006 and were carried at fair value with changes in fair value recorded through interest
expense. Effective January 1, 2007, we adopted FASB Staff Position (FSP) No. 00-19-02, Accounting
for Registration Payment Arrangements, which no longer requires the warrants to be recorded as
derivatives and no interest expense was recorded for these warrants during the nine months ended
September 30, 2007. See Note 5 Private Placement of Common Stock and Warrants for further
discussion.
Interest Income, Net
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended |
|
|
|
|
|
|
September 30, |
|
|
|
|
|
|
2007 |
|
2006 |
|
$ Change |
|
% Change |
(dollars in thousands) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest income, net |
|
$ |
402 |
|
|
$ |
434 |
|
|
$ |
(32 |
) |
|
|
(7.4 |
)% |
Percent of total revenues |
|
|
1.8 |
% |
|
|
2.1 |
% |
|
|
|
|
|
|
|
|
Interest income, net in the 2007 and 2006 periods includes interest income on a note
receivable for the 2003 sale of our urinary incontinence product line and interest income earned
from the investment of our cash balances. Interest income in 2007 also includes interest income
previously suspended in the amount of $0.1 million related to a note receivable from the 2006 sale
of Timm Medical.
25
Net Loss
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended |
|
|
|
|
|
|
September 30, |
|
|
|
|
|
|
2007 |
|
2006 |
|
$ Change |
|
% Change |
(dollars in thousands) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss |
|
$ |
(6,507 |
) |
|
$ |
(7,785 |
) |
|
$ |
(1,278 |
) |
|
|
(16.4 |
)% |
Percent of total revenues |
|
|
(28.6 |
)% |
|
|
(37.3 |
)% |
|
|
|
|
|
|
|
|
Net loss for the nine months ended September 30, 2007 was $0.59 per basic and diluted share on
10.9 million weighted average shares outstanding, compared to a net loss of $0.77 per basic and
diluted share on 10.1 million weighted average shares outstanding during the same period in 2006.
Liquidity and Capital Resources
Since inception, we have incurred losses from operations and have reported negative cash
flows. As of September 30, 2007, we had an accumulated deficit of $187.3 million and cash and cash
equivalents of $7.6 million.
We do not expect to reach cash flow positive operations on an annual basis in 2007, and we
expect to continue to generate losses from operations for the foreseeable future. These losses have
resulted in part from our continued investment to gain acceptance of our technology and investments
in initiatives that we believe should ultimately result in cost reductions. Although in July 2006
we resolved the investigations by the SEC and DOJ of our historical accounting and financial
reporting (see Note 10 Commitments and Contingencies), we still have obligations to indemnify
and advance the legal fees of our former officers and former directors in connection with the
ongoing investigations and legal proceedings related to those individuals. We expect that the
amount of those legal fees will exceed the reimbursement due to us from our directors and
officers liability insurance, and the excess may have a material adverse effect on our business,
financial condition, results of operations and liquidity. For the nine months ended September 30,
2007, we incurred expenses of $1.2 million relating to legal fees of former officers and former
directors, and recorded insurance recoveries of $0.8 million. As of September 30, 2007, there
remained an aggregate of $0.2 million available under this insurance coverage. For a description
of this insurance coverage, please refer to the Form 8-K that we filed on February 25, 2005 and
Note 10 Commitments and Contingencies.
We also face large cash expenditures in the future related to past due state and local taxes,
primarily sales and use tax obligations, which we estimate to be approximately $2.3 million. The
amount was fully accrued as of September 30, 2007. We are in the process of negotiating resolutions
of the past due state and local tax obligations with the applicable tax authorities. However,
there is no assurance that these obligations will be reduced as a result of the negotiations or
that we will be allowed to pay the amounts due over an extended period of time.
As discussed in Note 5 Private Placement of Common Stock and Warrants, on October 25,
2006, we entered into an agreement with Fusion Capital which gives us the right to sell to Fusion
Capital up to $16.0 million of common stock over a two year period at prices determined based upon
the market price of our common stock at the time of each sale without any fixed discount (in
$100,000 increments every fourth business day, with additional $150,000 increments available every
third business day if the market price per share of our common stock is $4.50 or higher), subject
to our ability to comply with certain ongoing requirements. These requirements include, among
others, maintaining effectiveness of the registration statement covering the sale of the shares
purchased by Fusion Capital, and maintenance of per share trading prices at or above $3.00. The
$150,000 increment can be increased if the market price of our common stock increases. The SEC
declared the registration statement effective on December 1, 2006.
Through September 30, 2007 we have sold 293,397 shares of stock to Fusion Capital for total
gross proceeds of $1.6 million. Since we have authorized 2,666,666 shares for sale under the stock
purchase agreement, the selling price of our common stock to Fusion Capital would have had to
average at least $6.00 per share for us to receive the maximum proceeds of $16.0 million. We are
obligated to pay a transaction fee equal to 6.0 percent of the stock proceeds to an investment
advisory firm under a pre-existing capital advisory agreement.
On May 24, 2007 we sold 1,085,271 shares of our common stock to Frazier Healthcare V, L.P. at
a price per share of $6.45, for aggregate proceeds of $7.0 million.
We expect to use existing cash reserves, working capital through the sale of our products, as
well as future proceeds from sales, if any, of common stock to Fusion Capital, to finance our
projected operating and cash flow
26
needs, along with continued expense management efforts. In addition, we may borrow funds under
our line of credit with our bank as long as we remain in compliance with the representations,
warranties, covenants and borrowing conditions set forth in the agreements governing the line of
credit. The funds we can borrow are based on eligible trade receivables and inventory as defined.
The credit facility includes a subjective acceleration clause and a requirement to maintain a lock
box with the lender, the proceeds from which will be applied to reduce the outstanding borrowings
upon our default or if other conditions are met. We were not in compliance with the minimum
tangible net worth covenant under our bank line of credit for the months of September to November
2006. On December 22, 2006, we signed an amendment to the Loan and Security Agreement. Among other
things, the amendment (i) modifies the borrowing base to increase the eligible accounts receivable
from 80 percent to 85 percent and modifies the definition of accounts that are ineligible under the
borrowing base calculation; (ii) modifies the loan margin as defined to 1.50 percent; and
(iii) waives non-compliance with the minimum tangible net worth requirement as of September 30,
2006, October 31, 2006 and November 30, 2006, as well as modifies the terms of the covenant. On
February 23, 2007, the credit agreement was amended to further modify the minimum tangible net
worth provision and to extend the maturity date to February 27, 2008. As of December 31, 2006 and
September 30, 2007, we were in compliance with all covenants. As of September 30, 2007 we had $0.9
million outstanding on the line of credit. During February through May 2007, outstanding advances
exceeded 50 percent of the accounts receivable borrowing base referred to above. As required by
the agreement, our lock-box proceeds were applied daily to reduce the outstanding advances and we
re-borrowed the amount subject to the lenders approval. In June 2007, outstanding advances were
reduced to less than 50 percent of the receivable borrowing base, and we were no longer required to
repay and re-borrow funds on a daily basis as of July 13, 2007.
Our cash needs are not entirely predictable and the future availability of funds from Fusion
Capital and our bank is subject to many conditions, including certain subjective acceleration
clauses and other provisions, some of which are predicated on events that are not within our
control. Accordingly, we cannot guarantee the availability of these capital resources or that they
will be sufficient to fund our ongoing operations to the point where our operations will generate
positive cash flows on a consistent basis. Because of the subjective acceleration clauses and
other contingencies referred to above, the audit report of our independent auditors contained in
our Annual Report on Form 10-K filed on March 16, 2007 contains an unqualified opinion with an
explanatory paragraph, to the effect that there is substantial doubt about our ability to continue
as a going concern.
However, we believe that the Fusion Capital financing and bank line of credit, together with
the $7.0 million that we received from Frazier Healthcare V, L.P., should provide us with the
capital resources that we need to reach the point where our operations will generate positive cash
flows on a consistent basis.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
The primary objective of our investment activities is to preserve principal while at the same
time maximizing the income we receive from our invested cash without significantly increasing risk
of loss. Our financial instruments include cash, cash equivalents, accounts and notes receivable,
minority investments, accounts payable, accrued liabilities and bank debt. As of September 30,
2007, the carrying values of our financial instruments approximated their fair values. Our practice
is not to enter into derivative financial instruments. In addition, we do not enter into any
futures or forward contracts and therefore we do not have significant market risk exposure with
respect to commodity prices.
Although we transact our business in U.S. dollars, future fluctuations in the value of the
U.S. dollar may affect the price competitiveness of our products. However, we do not believe that
we currently have any significant direct foreign currency exchange rate risk and have not hedged
exposures denominated in foreign currencies or any other derivative financial instruments.
Item 4. Controls and Procedures
(a) Evaluation of Disclosure Controls and Procedures. We maintain disclosure controls and
procedures that are designed to ensure that information required to be disclosed in our reports
pursuant to the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and
reported within the time periods specified in the SECs rules and forms and that such information
is accumulated and communicated to our management, including our chief executive officer and chief
financial officer, as appropriate, to allow for timely decisions regarding
27
required disclosure. In designing and evaluating the disclosure controls and procedures,
management recognizes that any controls and procedures, no matter how well designed and operated,
can provide only reasonable assurance of achieving the desired control objectives, and management
is required to apply its judgment in evaluating the cost-benefit relationship of possible controls
and procedures.
As required by Rule 13a-15(b) of the Securities Exchange Act of 1934, as amended, we carried
out an evaluation, under the supervision and with the participation of our management, including
our chief executive officer and chief financial officer, of the effectiveness of the design and
operation of our disclosure controls and procedures as of the end of the quarter covered by this
report. Based on the foregoing, our chief executive officer and chief financial officer concluded
that our disclosure controls and procedures were effective at the reasonable assurance level.
(b) Changes in Internal Controls. There was no change in our internal control over financial
reporting during our third fiscal quarter for 2007 that has materially affected, or is reasonably
likely to materially affect, our internal control over financial reporting.
28
PART II OTHER INFORMATION
Item 1. Legal Proceedings
Please refer to the legal proceedings described in Part I, Item 3, Legal Proceedings in the
Form 10-K that we filed on March 16, 2007 and in Part II, Item 1, Legal Proceedings in the Form
10-Q that we filed on May 9, 2007. There have been no new reportable legal proceedings or material
developments since the prior quarter, except for the following item:
As reported in the Form 8-K that we filed on September 17, 2007, we settled our
previously-disclosed litigation with KPMG LLP on September 11, 2007. The parties granted mutual
releases and dismissed their respective claims in the litigation. In addition, pursuant to the
settlement, on October 11, 2007 KPMG paid us a settlement amount
of $1.0 million and returned to us
fees in the amount of $0.2 million. Under a preexisting contingency fee agreement, we paid one-third
of the settlement amount and one-third of the returned fees to our outside litigation counsel.
Item 1A. Risk Factors
Please see our 2006 Annual Report on Form 10-K filed with the SEC on March 16, 2007, which
includes a detailed discussion of our risk factors. Please see also the updated risk factor
included in our second quarter Form 10-Q filed with the SEC on August 7, 2007. There have been no
material changes in our risk factors from those disclosed in the Form 10-K and the second quarter
Form 10-Q, except for updating the following risk factor to reflect uncertainty regarding new rules
or guidance expected to be issued in 2008 by the Centers for Medicare and Medicaid Services (CMS)
with respect to the federal Stark law:
We could be negatively impacted by future interpretation or implementation of the federal
anti-kickback and Stark laws and other federal and state anti-self-referral and anti-kickback laws.
The federal Stark law prohibits a physician from referring Medicare patients for certain
designated health services to an entity with which the physician has a financial relationship. A
financial relationship includes both investment interests in an entity and compensation
arrangements with an entity. The federal anti-kickback law prohibits the offer or receipt of any
remuneration in order to induce referrals of federal health care program business. Many states have
similar and often broader laws. These state laws generally apply to services reimbursed by both
governmental and private payers. Violation of these federal and state laws may result in
prohibition of payment for services rendered, loss of licenses, fines, criminal penalties and
exclusion from governmental and private payer programs, among other things. We have financial
relationships with physicians and physician-owned entities, which in turn have financial
relationships with hospitals and other providers of designated health services. Although we believe
that our financial relationships with physicians and physician-owned entities, as well as the
relationships between physician-owned entities that purchase or lease our products and hospitals,
are not in violation of applicable laws and regulations, governmental authorities might take a
contrary position.
CMS recently issued a final rule, making a number of changes to the current Stark law
regulations. The final rule, which will be effective December 4, 2007, does not appear to change
the current status of our financial relationships. However, CMS also recently issued proposed
regulations, inviting public comment on various additional Stark law proposals which could,
depending on the final version of those regulations and how they are interpreted, change the status
of certain financial relationships between hospitals and physician-owned entities that purchase or
lease our products. As of November 2007, CMS has decided to delay publication of the final version
of those proposed Stark law rules. We expect that CMS will issue the new rules, and may issue
additional guidance, in 2008. However, we are unable to predict whether, and the extent to which,
the new rules or guidance will affect our business. Depending on the content of the new rules or
guidance, we may incur significant time and expenses in the future to restructure existing business
relationships.
If our financial relationships with physicians or physician-owned entities or the
relationships between those entities and hospitals were found to be illegal, we and/or the affected
physicians and hospitals could be subject to civil and criminal penalties, including fines,
exclusion from participation in government and private payer programs and requirements to refund
amounts previously received from government and private payers. In addition, expansion of our
operations to new jurisdictions, or new interpretations of laws in our existing jurisdictions,
could require
29
structural and organizational modifications of our relationships with physicians,
physician-owned entities and others to comply with that jurisdictions laws.
We believe that the arrangements we have established with physician-owned entities and
hospitals comply with applicable Stark law exceptions. However, if any of the relationships between
physicians and hospitals involving our services do not meet a Stark law exception, the hospital
would not be permitted to bill for any services resulting from referral of a Medicare patient by
the affected physician(s). Although we are not the direct provider and do not bill Medicare for the
designated health services, any Stark law problem with our business arrangements with physicians
and hospitals would adversely affect us as well as the referring physician and the hospital
receiving the referral.
Many states also have patient referral laws, some of which are more restrictive than the Stark
law and regulate referrals by all licensed health care practitioners for any health care service to
an entity with which the licensee has a financial relationship unless an exception applies. Such
laws in particular states may prohibit us from entering into relationships with physicians and
physician-owned entities, which may limit business development.
We believe that our business practices comply with the Stark law, the federal anti-kickback
and applicable state anti-kickback and anti-self-referral laws. No assurance can be made, however,
that these practices would not be successfully challenged and penalties, such as civil money
penalties and exclusion from Medicare and Medicaid, and/or state penalties, imposed. And again,
mere challenge, even if we ultimately prevail, could have a material adverse effect on our
business, financial condition, results of operations and cash flows.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Not applicable.
Item 3. Defaults Upon Senior Securities
Not applicable.
Item 4. Submission of Matters to a Vote of Security Holders
Not applicable.
Item 5. Other Information
None.
Item 6. Exhibits
A list of exhibits to this Form 10-Q is found in the Exhibit Index immediately following the
Signature Page of this Form 10-Q, which is hereby incorporated by reference herein.
30
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly
caused this Form 10-Q to be signed on its behalf by the undersigned, thereunto duly authorized.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
ENDOCARE,
|
|
INC. |
|
|
|
|
|
|
|
|
|
|
|
By:
|
|
/s/ CRAIG T. DAVENPORT |
|
|
|
|
|
|
|
|
|
|
|
|
|
Craig T. Davenport |
|
|
|
|
|
|
Chief Executive Officer, President and |
|
|
|
|
|
|
Chairman of the Board |
|
|
|
|
|
|
(Duly Authorized Officer) |
|
|
|
|
|
|
|
|
|
|
|
By:
|
|
/s/ MICHAEL R. RODRIGUEZ |
|
|
|
|
|
|
|
|
|
|
|
|
|
Michael R. Rodriguez |
|
|
|
|
|
|
Senior Vice President, Finance and |
|
|
|
|
|
|
Chief Financial Officer |
|
|
|
|
|
|
(Principal Financial and |
|
|
|
|
|
|
Accounting Officer) |
|
|
Date:
November 6, 2007
31
EXHIBIT INDEX
|
|
|
Exhibit |
|
|
No. |
|
Description |
2.1(1)
|
|
Stock Purchase Agreement, dated January 13, 2006, by and among the Company, Plethora
Solutions Holdings plc and Timm Medical Technologies, Inc. The schedules and other
attachments to this exhibit were omitted. The Company agrees to furnish a copy of any
omitted schedules or attachments to the Securities and Exchange Commission upon request. |
|
|
|
2.2(2)
|
|
$1,425,000 Secured Convertible Promissory Note, dated February 10, 2006, from Plethora
Solutions Holdings plc to the Company. |
|
|
|
3.1(3)
|
|
Restated Certificate of Incorporation. |
|
|
|
3.2(3)
|
|
Certificate of Designation of Series A Junior Participating Preferred Stock of the Company. |
|
|
|
3.3(3)
|
|
Certificate of Amendment of Restated Certificate of Incorporation, as filed with the
Delaware Secretary of State on September 25, 2000. |
|
|
|
3.4(4)
|
|
Certificate of Amendment of Restated Certificate of Incorporation, as filed with the
Delaware Secretary of State on August 17, 2007. |
|
|
|
3.4(5)
|
|
Amended and Restated Bylaws of the Company. |
|
|
|
4.1(6)
|
|
Form of Stock Certificate. |
|
|
|
4.2(7)
|
|
Form of Series A Warrant. |
|
|
|
4.3(7)
|
|
Form of Series B Warrant. |
|
|
|
4.4(8)
|
|
Rights Agreement, dated March 31, 1999, between the Company and U.S. Stock Transfer
Corporation, which includes the form of Certificate of Designation for the Series A Junior
Participating Preferred Stock as Exhibit A, the form of Rights Certificate as Exhibit B
and the Summary of Rights to Purchase Series A Preferred Shares as Exhibit C. |
|
|
|
4.5(9)
|
|
Amendment No. 1 to Rights Agreement, dated September 24, 2005, between the Company and
U.S. Stock Transfer Corporation. |
|
|
|
10.1(10)
|
|
First Amendment to Employee Deferred Stock Unit Program, dated August 6, 2007. |
|
|
|
10.2(10)
|
|
First Amendment to Non-Employee Director Deferred Stock Unit Program, dated August 6, 2007. |
|
|
|
10.3
|
|
Memorandum of Understanding, dated September 11, 2007, between the Company and KPMG LLP. |
|
|
|
31.1
|
|
Certification under Section 302 of the Sarbanes-Oxley Act of 2002 for Craig T. Davenport. |
|
|
|
31.2
|
|
Certification under Section 302 of the Sarbanes-Oxley Act of 2002 for Michael R. Rodriguez. |
|
|
|
32.1
|
|
Certification under Section 906 of the Sarbanes-Oxley Act of 2002 for Craig T. Davenport. |
|
|
|
32.2
|
|
Certification under Section 906 of the Sarbanes-Oxley Act of 2002 for Michael R. Rodriguez. |
|
|
|
(1) |
|
Previously filed as an exhibit to our Form 8-K filed on January 18, 2006. |
|
(2) |
|
Previously filed as an exhibit to our Form 10-K filed on March 16, 2006. |
32
|
|
|
(3) |
|
Previously filed as an exhibit to our Registration Statement on Form S-3 filed on September 20, 2001. |
|
(4) |
|
Previously filed as an exhibit to our Form 8-K filed on August 21, 2007. |
|
(5) |
|
Previously filed as an exhibit to our Form 10-K filed on March 15, 2004. |
|
(6) |
|
Previously filed as an exhibit to our Form 10-K for the year ended December 31, 1995. |
|
(7) |
|
Previously filed as an exhibit to our Form 8-K filed on March 16, 2005. |
|
(8) |
|
Previously filed as an exhibit to our Form 8-K filed on September 3, 1999. |
|
(9) |
|
Previously filed as an exhibit to our Form 8-K filed on September 28, 2005. |
|
(10) |
|
Previously filed as an exhibit to our Form 8-K filed on August 8, 2007. |
33