e10vq
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, 2005
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
(State of Incorporation)
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33-0618093
(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 an accelerated filer (as defined in Rule
12b-2 of the Exchange Act). Yes þ
No 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 $.001 per share,
outstanding at October 24, 2005 was 30,073,519.
PART I FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements
ENDOCARE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
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Three Months Ended |
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Nine Months Ended |
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September 30, |
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September 30, |
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2005 |
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2004 |
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2005 |
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2004 |
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(Unaudited) |
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(In thousands, except per share data) |
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Total revenues |
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$ |
9,465 |
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$ |
8,365 |
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$ |
27,670 |
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$ |
24,059 |
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Costs and expenses: |
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Cost of revenues |
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4,571 |
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4,274 |
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14,218 |
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12,821 |
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Research and development |
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440 |
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422 |
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1,346 |
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1,410 |
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Selling and marketing |
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4,100 |
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3,619 |
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12,294 |
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13,146 |
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General and administrative |
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3,883 |
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3,375 |
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11,804 |
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14,116 |
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Impairment charge |
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15,810 |
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(583 |
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15,810 |
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Total costs and expenses |
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12,994 |
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27,500 |
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39,079 |
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57,303 |
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Loss from operations |
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(3,529 |
) |
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(19,135 |
) |
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(11,409 |
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(33,244 |
) |
Interest income (expense), net |
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639 |
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73 |
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(182 |
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194 |
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Loss before minority interests |
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(2,890 |
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(19,062 |
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(11,591 |
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(33,050 |
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Minority interests |
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(195 |
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(450 |
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Net loss |
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$ |
(2,890 |
) |
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$ |
(19,257 |
) |
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$ |
(11,591 |
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$ |
(33,500 |
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Net loss per share basic and diluted |
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$ |
(0.10 |
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$ |
(0.80 |
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$ |
(0.40 |
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$ |
(1.38 |
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Weighted average shares of common stock outstanding |
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30,069 |
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24,175 |
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28,975 |
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24,263 |
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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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2005 |
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2004 |
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(Unaudited) |
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(In thousands, except per |
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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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$ |
11,127 |
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$ |
7,985 |
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Accounts receivable, net |
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4,088 |
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3,904 |
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Inventories, net |
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3,125 |
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3,175 |
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Prepaid expenses and other current assets |
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1,381 |
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1,651 |
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Total current assets |
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19,721 |
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16,715 |
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Property and equipment, net |
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1,914 |
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3,139 |
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Goodwill |
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4,552 |
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4,552 |
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Intangibles, net |
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8,098 |
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8,560 |
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Investments and other assets |
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1,042 |
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1,409 |
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Total assets |
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$ |
35,327 |
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$ |
34,375 |
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LIABILITIES AND STOCKHOLDERS EQUITY |
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Current liabilities: |
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Accounts payable |
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$ |
2,860 |
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$ |
2,636 |
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Accrued compensation |
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3,557 |
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3,708 |
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Other accrued liabilities |
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7,727 |
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10,391 |
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Total current liabilities |
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14,144 |
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16,735 |
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Common stock warrants |
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6,305 |
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Total liabilities |
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20,449 |
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16,735 |
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Minority interests |
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214 |
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Stockholders equity: |
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Preferred stock, $.001 par value; 1,000
shares authorized; none issued and
outstanding |
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Common stock, $.001 par value; 50,000
shares authorized; 30,074 and 24,342
issued and outstanding as of September
30, 2005 and December 31, 2004,
respectively |
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30 |
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24 |
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Additional paid-in capital |
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178,439 |
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169,400 |
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Accumulated deficit |
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(163,591 |
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(151,998 |
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Total stockholders equity |
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14,878 |
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17,426 |
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Total liabilities and stockholders equity |
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$ |
35,327 |
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$ |
34,375 |
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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 |
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September 30, |
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2005 |
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2004 |
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(Unaudited) |
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(In thousands) |
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Cash flows from operating activities: |
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Net loss |
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$ |
(11,591 |
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$ |
(33,500 |
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Adjustments to reconcile net loss to net cash used in
operating activities: |
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Depreciation and amortization |
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2,502 |
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2,755 |
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Impairment charge |
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(583 |
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15,810 |
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Loss on disposals of fixed assets |
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107 |
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Compensation expense related to issuance of options and warrants |
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49 |
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134 |
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Minority interests |
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(214 |
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450 |
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Interest expense related to common stock warrants |
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625 |
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Changes in operating assets and liabilities: |
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Accounts receivable |
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(184 |
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286 |
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Inventories |
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(368 |
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(1,755 |
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Prepaid expenses and other current assets |
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(239 |
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(470 |
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Accounts payable |
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224 |
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(587 |
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Accrued compensation |
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(151 |
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(112 |
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Other accrued liabilities |
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(1,986 |
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1,770 |
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Net cash used in operating activities |
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(11,809 |
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(15,219 |
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Cash flows from investing activities: |
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Sales of property and equipment |
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362 |
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Purchases of property and equipment |
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(246 |
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(522 |
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Purchases of intangible assets |
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(330 |
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Proceeds from divestitures |
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850 |
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2,604 |
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Partnership distributions to minority interests |
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(599 |
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Decrease in other assets |
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275 |
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Net cash provided by investing activities |
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274 |
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2,120 |
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Cash flows from financing activities: |
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Stock options and warrants exercised |
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81 |
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92 |
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Proceeds from sale of common stock and warrants, net of issuance costs |
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14,596 |
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Treasury stock received in settlement |
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(504 |
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Net cash provided by (used in) financing activities |
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14,677 |
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(412 |
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Net increase (decrease) in cash and cash equivalents |
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3,142 |
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(13,511 |
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Cash and cash equivalents, beginning of period |
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7,985 |
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23,977 |
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Cash and cash equivalents, end of period |
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$ |
11,127 |
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$ |
10,466 |
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Non-cash activities: |
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Transfer of inventory to property and equipment |
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$ |
418 |
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$ |
508 |
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Retirement of treasury shares held |
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2,596 |
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Deferred compensation on options forfeited |
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94 |
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The accompanying notes are an integral part of these condensed consolidated financial statements.
5
ENDOCARE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Tabular numbers in thousands, except per share data)
(Unaudited)
1. Organization and Operations of the Company
Endocare, Inc. (Endocare) is a medical device company focused on developing, manufacturing
and selling cryoablation products with the potential to improve the treatment of cancer and other
tumors. In addition, we offer vacuum therapy systems for non-pharmaceutical treatment of erectile
dysfunction. Endocare was 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 its incorporation under the laws of the state of Delaware in
1994, Endocare became an independent, publicly-owned corporation upon Medstones distribution of
Endocares stock to the existing stockholders on January 1, 1996.
2. Basis of Presentation
Following the rules and regulations of the Securities and Exchange Commission (the 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 December 31, 2004 Annual Report on Form 10-K, filed with the SEC on
March 16, 2005, as amended on September 16, 2005.
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.
3. Recent Operating Results and Liquidity
Since inception, we have incurred losses from operations and have reported negative cash
flows. As of September 30, 2005, we had an accumulated deficit of $163.6 million and cash and cash
equivalents of $11.1 million. In addition to the cash needed to fund our ongoing operations, there
will continue to be substantial demands on cash related to ongoing investigations of our historical
accounting and financial reporting. Regulators may fine us, or we may agree to make one or more
settlement payments in order to resolve the matters under investigation. We also have obligations
to indemnify our former officers and former directors in connection with those investigations.
For the nine months ended September 30, 2005 and the year ended December 31, 2004, we incurred
$4.0 million and $7.1 million, respectively, in legal, audit and accounting support fees related to
these matters, including costs related to our efforts to achieve compliance with the internal
control reporting requirements of Section 404 of the Sarbanes-Oxley Act. We also face large cash
expenditures in the future related to past due state and local tax obligations, for which we
estimated and accrued $3.4 million as of September 30, 2005. We currently are in negotiations with
various states to resolve past due taxes. However, there is no assurance that these obligations
will be reduced or that we will be allowed to pay the amounts due over an extended period of time.
During the fourth quarter of 2005, we expect to pay $1.0 million to our excess insurance carrier
pursuant to a settlement agreement expected during November 2005. We also expect to pay
$750,000 in civil penalties when the proposed settlement with the Securities and Exchange Commission
(SEC) is approved.
We
have continued to experience growth in cryosurgical disposable
products and
procedure fee revenues and have
significantly reduced our operating costs through streamlining our corporate organization, reducing
staff, elimination or deferral of some longer-term research and development and clinical and
marketing activities, reconfiguration of our products to reduce manufacturing costs and
transferring manufacturing to lower cost suppliers and in general
better controlling of operating expenses. We have also secured a credit facility in
October 2005 that could provide up to $4.0 million in borrowings to finance working capital
needs, subject to certain borrowing limitations.
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ENDOCARE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
If we do not generate positive cash flows from
operations we may need to raise additional capital which may not be available on terms acceptable
to us, or at all. Any additional equity financing may be dilutive to stockholders, and debt
financing, if available, may involve interest expense and restrictive covenants.
4. Changes to Plan of Sale Timm Medical
In July 2004, we began actively marketing Timm Medical Technologies, Inc. (Timm Medical), our
wholly-owned subsidiary, and our equity interests in the mobile prostate treatment businesses
(collectively the Disposal Group) to potential buyers as part of an overall plan to raise
additional capital. 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 the
Disposal Group were classified as assets held for sale as of that date. In connection with the
potential sale, we reduced the carrying value of these assets and liabilities to fair value less
estimated cost to sell and suspended depreciation of fixed assets and amortization of intangibles
as of July 31, 2004. As a result, we recorded an impairment charge of $15.8 million in the third
quarter of 2004, of which $5.9 million related to the write-down of goodwill and developed
technology at Timm Medical.
We
completed the sale of the mobile prostate treatment businesses in December 2004. By the end of March
2005, we had not found a suitable buyer for Timm Medical, our
wholly-owned subsidiary. With the
successful completion of a private placement of our common stock in March 2005 (see Note 5) in
which we raised $14.6 million in new capital, net of issuance
costs, we determined that we would no longer seek a buyer
and ceased all marketing efforts in April 2005. In accordance with SFAS No. 144, we measured Timm
Medicals assets and liabilities individually at the (a) lower of its carrying amount before they
were classified as held for sale, adjusted for any depreciation (amortization) expense or
impairment losses that would have been recognized had the net asset group been continuously
classified as held and used or (b) fair value at March 31, 2005. Based on this review, we recorded
$0.4 million in depreciation of fixed assets and amortization of intangibles for the period from
July 31, 2004 to March 31, 2005 (included in general and administrative expenses). We also recorded
income of $0.6 million as a result of the elimination of the estimated costs to sell, which were
previously reported as a component of the impairment charge. The condensed consolidated balance
sheet at December 31, 2004 has been reclassified to reflect the Timm Medical assets and liabilities
as held and used.
We completed the sale of the mobile prostate treatment businesses in December 2004 and
retained three mobile prostate treatment businesses, all of which are inactive and are being dissolved.
These residual interests are not significant and are accounted for on the equity method.
5. Private Placement of Common Stock and Warrants
On March 11, 2005, we completed a private placement of 5,635,378 shares of our common stock
and detachable warrants to purchase 3,944,748 common shares at an offering price of $2.77 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, 1,972,374 have an initial exercise
price of $3.50 (Series A warrants) per share and 1,972,374 have an initial exercise price
of $4.00 (Series B warrants) per share.
The warrants initially are exercisable at any time during the next five years 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 Endocare at a price of
$0.01 per share underlying such warrant if Endocares stock trades above certain dollar thresholds
($6.50 for the Series A warrants and $7.50 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
7
ENDOCARE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
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% of the warrant proceeds under an
existing capital advisory agreement.
Pursuant to the terms of the registration rights agreement, 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 underlying the issued
warrants. The S-2 registration statement was declared effective September 28, 2005.
The registration rights agreement further 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 1% per month of the aggregate purchase price paid by such
holder. We incurred liquidated damages through September 28, 2005, when the S-2 registration
statement was declared effective. For the three and nine months ended September 30, 2005, we
incurred $0.5 and $0.6 million of liquidated damages, respectively, which are included in general
and administrative expenses.
The registration rights agreement into which we entered in connection with our issuance of the
warrants requires us to pay liquidated damages, which in some cases could exceed a reasonable
discount for delivering unregistered shares and thus, we have classified the warrants as a
liability until the earlier of the date the warrants are exercised or expire. In accordance with
EITF 00-19, Accounting for Derivative Financial Instruments Indexed To, and Potentially Settled In,
a Companys Own Stock, we have allocated a portion of the offering proceeds to the warrants based
on their fair value. EITF 00-19 also requires that we revalue the warrants as a derivative
instrument periodically to compute the value in connection with changes in the underlying stock
price and other assumptions, with the change in value recorded as interest expense or interest
income. We determined the fair value of the warrants as follows as of September 30, 2005:
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First, we used the Black-Scholes option-pricing model with the following assumptions:
an expected life equal to the remaining contractual term of the warrants (4.50 years); no
dividends; a risk free rate of 4.16%, which equals the yield on Treasury bonds at constant
(or fixed) maturity equal to the remaining contractual term of the warrants; and volatility
of 109.7 %. Under these assumptions, the Black-Scholes option-pricing model yielded a
value of $2.50 for each of the Series A warrants and $2.45 for each of the Series B
warrants, for an aggregate value of $9.8 million; |
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Second, since the warrants are limited in the amount of realizable profit to the
holders as a result of the call provision described above, we reduced the value of the
warrants to account for the probability that the stock price will reach or exceed $6.50 and
$7.50, respectively (i.e., the prices above which we have the right to call the Series A
and Series B warrants, effectively compelling the holders to exercise their warrants). We
used a statistical formula to calculate the probability that our stock price will reach or
exceed $6.50 and $7.50, respectively. Based on this formula, we calculated that, for the
Series A warrants, the probability that the stock price of $6.50 will be reached or
exceeded is approximately 33.4%. Similarly, we calculated that, for the Series B warrants,
the probability that the stock price of $7.50 will be reached or exceeded is approximately
28.7%. Based on these probabilities, we reduced the valuation of each of the Series A
warrants to $1.66 (which equals one minus 33.4%, multiplied by $2.50) and we reduced the
valuation of each of the Series B warrants to $1.74 (which equals one minus 28.7%,
multiplied by $2.45). This yields an aggregate value of the warrants equal to $6.7
million; and |
8
ENDOCARE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
|
|
|
Third, we further reduced the value of the warrants on the assumption that our stock
price on the day that the warrants are exercised will be affected by dilution as a result
of the additional stock introduced into the market. Given that we have approximately 30
million shares outstanding, we calculated that the exercise of the warrants will result in
dilution of approximately 6.2%. Using the dilution figure of 6.2%, we reduced the value of
each of the Series A warrants to $1.56 and the Series B warrants to $1.64. This yields an
aggregate value of the warrants equal to $6.3 million. |
As a result of this fair value calculation, we recorded negative interest expense of $0.5 million for
the three months ended September 30, 2005, which represents the change in the fair value of the
warrants from June 30, 2005. This change was primarily due to a decrease in the fair value of the
underlying common stock from $4.00 as of June 30, 2005 to $3.25 as of September 30, 2005. Total
net interest expense related to the warrant valuation was $0.6 million for the nine months ended
September 30, 2005.
Upon the earlier of the warrant exercise or expiration date, the warrant liability will be
reclassified into stockholders equity. Until that time, the warrant liability will be recorded at
fair value based on the methodology described above. We do not expect that the warrants will be
exercised within the next 12 months based on the current trading prices of our common stock and
have classified the warrants as a non-current liability at September 30, 2005. Changes in fair
value during each period will be recorded as interest expense. Liquidated
damages under the registration rights agreement are expensed as incurred.
Two members 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.
6. 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.
During the first quarter of 2004, we retired 326,222 of its common shares held in treasury,
including 120,022 shares repurchased from a third party for approximately $504,000 in February 2004
in conjunction with a litigation settlement.
7. Stock-Based Compensation
We have elected to follow Accounting Principles Board (APB) Opinion No. 25, Accounting for
Stock Issued to Employees, and related interpretations in accounting for our employee stock
options. Under APB 25, if the exercise price of the employee and director stock options is less
than the estimated fair value of the underlying stock on the date of grant, we record deferred
compensation for the difference. In practice, we generally award
stock options to our employees
with exercise prices equal to the fair value of the underlying common stock at the date of grant.
Option or stock awards issued to non-employees are recorded at their fair value as determined
by the Black-Scholes option-pricing model in accordance with Emerging Issues Task Force (EITF)
96-18, Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or
in Conjunction with Selling, Goods and Services. Such awards are periodically revalued as the
options vest and are recognized as expense over the related service period or as performance goals
are achieved.
9
ENDOCARE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Pro forma information regarding our net loss is required by SFAS 123, as amended by SFAS No.
148, Accounting for Stock-Based Compensation Transition and Disclosure, and has been determined
as if we had accounted for our employee stock options under the fair value method of SFAS 123, as
amended by SFAS 148. The pro forma effects of stock-based compensation on net loss and net loss
per share have been estimated at the date of grant using the Black-Scholes option-pricing model.
The following table illustrates the effect on net losses if we had applied the fair value
recognition provisions of SFAS 123 to stock-based compensation:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Nine Months Ended |
|
|
|
September 30, |
|
|
September 30, |
|
|
|
2005 |
|
|
2004 |
|
|
2005 |
|
|
2004 |
|
Net loss, as reported |
|
$ |
(2,890 |
) |
|
$ |
(19,257 |
) |
|
$ |
(11,591 |
) |
|
$ |
(33,500 |
) |
Reconciling items: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Add: Stock-based employee
compensation expense determined
under the intrinsic-value-based
method for all awards |
|
|
|
|
|
|
121 |
|
|
|
|
|
|
|
134 |
|
Less: Stock-based compensation
expense determined under the
fair-value-based method for all
awards expense |
|
|
(936 |
) |
|
|
(795 |
) |
|
|
(2,756 |
) |
|
|
(2,151 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Net adjustment |
|
|
(936 |
) |
|
|
(674 |
) |
|
|
(2,756 |
) |
|
|
(2,017 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss, as adjusted |
|
$ |
(3,826 |
) |
|
$ |
(19,931 |
) |
|
$ |
(14,347 |
) |
|
$ |
(35,517 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic and diluted loss per share: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As reported |
|
$ |
(0.10 |
) |
|
$ |
(0.80 |
) |
|
$ |
(0.40 |
) |
|
$ |
(1.38 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
As adjusted |
|
$ |
(0.13 |
) |
|
$ |
(0.82 |
) |
|
$ |
(0.50 |
) |
|
$ |
(1.46 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
In December 2004, SFAS No. 123R, Share-Based Payment, was issued (SFAS 123R). SFAS 123R is a
revision of SFAS No. 123, Accounting for Stock Based Compensation, and supersedes APB 25. Among
other items, SFAS 123R eliminates the use of APB 25 and the intrinsic value method of accounting,
and requires companies to recognize the cost of employee services received in exchange for awards
of equity instruments, based on the grant date fair value of those awards, in the financial
statements. We are required to adopt SFAS 123R effective January 1, 2006. SFAS 123R permits
companies to adopt its requirements using either a modified prospective method, or a modified
retrospective method. Under the modified prospective method, compensation cost is recognized in
the financial statements beginning with the effective date, based on the requirements of SFAS 123R
for all share-based payments granted after that date, and based on the requirements of SFAS 123 for
all unvested awards granted prior to the effective date of SFAS 123R. Under the modified
retrospective method, the requirements are the same as under the modified prospective method,
but also permits entities to restate financial statements of previous periods based on proforma
disclosures made in accordance with SFAS 123.
We currently use the Black-Scholes standard option pricing model to measure the fair value of
stock options granted to employees. While SFAS 123R permits us to continue to use such a model,
the standard also permits the use of a lattice model. We will continue to use the Black-Scholes
model to measure the fair value of employee stock options upon the adoption of SFAS 123R.
SFAS 123R also requires that the benefits associated with the tax deductions in excess of
recognized compensation cost be reported as a financing cash flow, rather than as an operating cash
flow as required under current literature. This requirement will reduce net operating cash flows
and increase net financing cash flows in periods after the effective date. These future amounts
cannot be estimated, because they depend on, among other things, when employees exercise stock
options. Also, we have not recognized the benefits for excess tax deductions
in our operating cash flows in prior periods due to the uncertainty of when we will generate
taxable income to realize such benefits.
10
ENDOCARE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
We will adopt SFAS 123R effective January 1, 2006 using the modified prospective approach.
The adoption of SFAS 123Rs fair value method will have a significant impact on our results of
operations, although it will have no impact on our overall financial position and cash flows. The
impact of adoption of SFAS 123R cannot be predicted at this time because it will depend on levels
of share-based payments granted in the future. However, had we adopted SFAS 123R in prior periods,
the impact of that standard would have approximated the impact of SFAS 123 as described in the
disclosure of pro forma net loss and loss per share in the table above.
8. 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:
|
|
|
|
|
|
|
|
|
|
|
September 30, |
|
|
December 31, |
|
|
|
2005 |
|
|
2004 |
|
Raw materials |
|
$ |
1,751 |
|
|
$ |
1,727 |
|
Work in process |
|
|
214 |
|
|
|
446 |
|
Finished goods |
|
|
1,680 |
|
|
|
1,560 |
|
|
|
|
|
|
|
|
Total inventories |
|
|
3,645 |
|
|
|
3,733 |
|
Less inventory reserve |
|
|
(520 |
) |
|
|
(558 |
) |
|
|
|
|
|
|
|
Inventories, net |
|
$ |
3,125 |
|
|
$ |
3,175 |
|
|
|
|
|
|
|
|
9. Commitments and Contingencies
Legal Matters
In November 2002, we were named as a defendant, together with certain former officers, one of
whom is also a former board member, in a class-action lawsuit filed in the United States District
Court for the Central District of California. On February 2, 2003, the court issued an order
consolidating this action with various other similar complaints and ordering plaintiffs to file a
consolidated complaint, which was filed on October 31, 2003. The consolidated complaint asserted
two claims for relief, alleging that the defendants violated sections of the Securities Exchange
Act of 1934 by purportedly issuing false and misleading statements regarding our revenues and
expenses in press releases and SEC filings. Plaintiffs sought class certification and unspecified
damages from us, as well as forfeiture and reimbursement of bonus compensation received by two of
the individual defendants. On April 26, 2004, the court issued an order denying our motion to
dismiss the consolidated complaint. On November 8, 2004, we executed a settlement agreement with
the lead plaintiffs and their counsel. Under the agreement, in exchange for a release of all
claims, certain individuals and we agreed to pay a total of $8.95 million in cash. Our directors
and officers liability insurance carriers funded the total amount of $8.95 million prior to
December 31, 2004, subject to reservations of rights by the carriers. On February 7, 2005, the
Court issued a final order approving the agreement and dismissing the class-action lawsuit.
Of
the $8.95 million settlement referred to above, our primary
insurance carrier funded $1.2
million, our first excess insurance carrier funded $5.0 million and our second excess insurance
carrier funded $2.7 million. As a result of the insurance settlements disclosed in the current
reports on Form 8-K that we filed on December 20, 2004 and
February 25, 2005, the amounts funded by our primary insurance carrier ($1.2 million) and our
second excess insurance carrier ($2.7 million) no longer are subject to reservations of rights. In
November 2005 we expect to enter into an agreement to settle
with the first excess insurance carrier and to refund
$1.0 million to the carrier. As a result of the expected November 2005 settlement, we reduced the recorded
settlement liability from the $1.4 million recorded in 2004 to
$1.0 million as of September 30, 2005.
11
ENDOCARE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
On December 6, 2002, Frederick Venables filed a purported derivative action against us and
certain former officers, certain former board members and one current board member in the
California Superior Court for the County of Orange alleging breach of fiduciary duty, abuse of
control, gross mismanagement, waste of corporate assets and unjust enrichment. Pursuant to a
stipulation filed on or about April 23, 2004 and approved by the court, the deadline to respond to
the complaint was stayed until 2005. The complaint sought unspecified monetary damages, equitable
relief and injunctive relief based upon allegations that the defendants issued false and misleading
statements regarding our revenues and expenses in press releases and SEC filings. On December 6,
2004, we executed a settlement agreement with the plaintiff and his counsel. On December 8, 2004,
the Court issued a final order approving the agreement and dismissing the derivative lawsuit.
Under the agreement, in exchange for the plaintiffs release of all claims, we paid a total of $0.5
million in cash prior to December 31, 2004 to cover the fees and expenses of the plaintiffs
counsel. The agreement also requires us to maintain various corporate governance measures for a
period of at least two years, unless a modification is necessary in the good faith business
judgment of our Board of Directors.
The corporate governance measures include new signature authorization and approval policy and
procedures, new sales order processing and invoicing procedures, new contracts approval and
management policies and procedures, new credit policies, new purchasing controls, new policies and
procedures for cash management, collections and disbursements, new policy for recognition and
recording of revenues and expenses, employee attestations, employee training, creation of risk
oversight committee, updated employee handbook, expanded corporate compliance program,
whistleblower hotline and upgraded accounting and finance department.
We have been in settlement discussions with the staff of the SEC regarding the terms of a
settlement of the previously announced investigation commenced by the SEC in January 2003 related
to allegations that we and certain of our current and former officers and directors issued, or
caused to be issued, false and misleading financial statements in prior periods. The proposed
settlement which has been agreed upon by the staff and remains subject both to final approval by
the SEC and court, includes the following principal terms: (i) we would pay a total of $750,000 in
civil penalties (accrued as of December 31, 2004); (ii) we would agree to a stipulated judgment
enjoining future violations of securities laws; and (iii) we would agree to maintain various
improvements in our internal controls that have previously been implemented. If approved, the
proposed settlement would resolve all claims against us relating to the formal investigation that
the SEC commenced in January 2003.
As previously announced, the Department of Justice (DOJ) is conducting an investigation into
allegations that we and certain of our former officers, a former director and one current employee
intentionally issued, or caused to be issued, false and misleading statements regarding our
financial results and related matters. The DOJs investigation is ongoing and is not affected by
the proposed settlement with the SEC described above.
In addition, we are, in the normal course of business, 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, 2005, except for the
matters indicated above for which we have accrued $1.8 million (of which $750,000 relates to the
proposed settlement with the SEC and the balance of which relates to the directors and officers
liability insurance matters referred to above), we have not established a liability for
contingencies in the consolidated balance sheets since the
likelihood of loss and the potential liability cannot be reasonably estimated at this time.
Managements evaluation of the likelihood of an unfavorable outcome with respect to these actions
could change in the future. Our directors and officers liability and other insurance may fund
certain losses, including defense costs, related to the above
litigation matters. These recoveries
will be recorded when the amounts are determined to be recoverable from the insurance carriers.
12
ENDOCARE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
From time to time, we have received correspondence alleging infringement of proprietary rights
of third parties. No assurance can be given that any relevant claims of third parties would not be
upheld as valid and enforceable, and therefore we could be prevented from practicing the subject
matter claimed or would be required to obtain licenses from the owners of any such proprietary
rights to avoid infringement. We do not expect any material adverse effect on our consolidated
financial condition, results of operations, or cash flows because of such claims.
10. Income Taxes
We reported no income tax expense for each of the nine months ended September 30, 2005 and
2004 due to our operating losses. The continuing operating losses resulted in an increase in the
valuation allowance of $3.9 million and $12.2 million during the nine months ended September 30,
2005 and 2004, respectively. 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, 2005 and 2004.
11. Results of Operations
Revenues and cost of revenues related to the following products and services for the periods
ended September 30, 2005 and 2004 are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Nine Months Ended |
|
|
|
September 30, |
|
|
September 30, |
|
|
|
2005 |
|
|
2004 |
|
|
2005 |
|
|
2004 |
|
Revenues: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cryocare Surgical Systems |
|
$ |
132 |
|
|
$ |
320 |
|
|
$ |
404 |
|
|
$ |
570 |
|
Cryoablation disposable products and procedure fees |
|
|
6,653 |
|
|
|
5,743 |
|
|
|
19,690 |
|
|
|
16,752 |
|
Cardiac royalties (CryoCath) |
|
|
203 |
|
|
|
150 |
|
|
|
645 |
|
|
|
441 |
|
Erectile dysfunction products (Timm Medical) |
|
|
2,477 |
|
|
|
2,152 |
|
|
|
6,931 |
|
|
|
6,296 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
9,465 |
|
|
$ |
8,365 |
|
|
$ |
27,670 |
|
|
$ |
24,059 |
|
Cost of Revenues: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cryocare Surgical Systems |
|
$ |
107 |
|
|
$ |
26 |
|
|
$ |
405 |
|
|
$ |
108 |
|
Cryoablation disposable products and procedure fees |
|
|
3,701 |
|
|
|
3,509 |
|
|
|
11,513 |
|
|
|
10,035 |
|
Cardiac royalties (CryoCath) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Erectile dysfunction products (Timm Medical) |
|
|
763 |
|
|
|
739 |
|
|
|
2,300 |
|
|
|
2,678 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
4,571 |
|
|
$ |
4,274 |
|
|
$ |
14,218 |
|
|
$ |
12,821 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues from the sales of cryoablation disposable products and cryoablation procedure fees
are comprised of the following for the periods ended September 30, 2005 and 2004:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Nine Months Ended |
|
|
|
September 30, |
|
|
September 30, |
|
|
|
2005 |
|
|
2004 |
|
|
2005 |
|
|
2004 |
|
Disposable products |
|
$ |
1,927 |
|
|
$ |
811 |
|
|
$ |
4,727 |
|
|
$ |
3,500 |
|
Procedure fees |
|
|
4,726 |
|
|
|
4,932 |
|
|
|
14,963 |
|
|
|
13,252 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
6,653 |
|
|
$ |
5,743 |
|
|
$ |
19,690 |
|
|
$ |
16,752 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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
ENDOCARE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
12. Recent Accounting Pronouncements
In May 2005, the Financial Accounting Standards Board (FASB) issued Statement No. 154 (SFAS
No. 154), Accounting Changes and Error Corrections, which replaced APB Opinion No. 20, Accounting
Changes, and SFAS No. 3, Reporting Changes in Interim Financial Statements. SFAS No. 154 requires
retrospective application to prior periods financial statements of voluntary changes in accounting
principles and changes required by a new accounting standard when the standard does not include
specific transition provisions. Previous guidance required most voluntary changes in accounting
principle to be recognized by including in net income of the period in which the change was made
the cumulative effect of changing to the new accounting principle. SFAS No. 154 carries forward
existing guidance regarding the reporting of the correction of an error and a change in accounting
estimate. SFAS No. 154 is effective for accounting changes and corrections of errors made in fiscal
years beginning after December 15, 2005. Adoption of SFAS No. 154 as of January 1, 2006 is not
expected to have a material effect on our consolidated financial position or results of operations.
Other recent accounting pronouncements issued by the FASB (including its Emerging Issues Task
Force), the AICPA, and the SEC did not, or are not believed by management to, have a material
impact on our present or future consolidated financial statements.
13.
Subsequent Event Revolving Line of Credit
On
October 26, 2005 we entered into a one year Loan and Security
Agreement with a bank which provides up to $4 million on a
revolving line of credit for working capital purposes.
Borrowings under the revolving line of credit are subject to a borrowing base formula based upon eligible accounts
receivable and inventories. We have not incurred any borrowing under this arrangement as of the
date of the filing of this Form 10-Q.
Under the Loan and Security Agreement, the outstanding balance bears interest payable monthly
at a variable rate based on the Prime Rate plus a loan margin based
on our quick ratio, as defined.
The revolving line of credit is collateralized by substantially all of our assets.
The Loan and Security Agreement 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 bank.
14
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, 2004, as amended.
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 in 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.
Strategy, Key Metrics and Developments
Our goal is to achieve a leading position in the prostate and renal cancer markets, and
further develop and increase the acceptance of our technology in the interventional radiology and
oncology markets for treatment of liver and lung cancers and management of pain from bone
metastases. At the same time, we seek to achieve penetration across additional markets with our
proprietary cryoablation technology, while maintaining our dominant position in vacuum technology
for erectile dysfunction.
Our primary objective for our cryoablation business is to grow market share, measured in terms
of the number of procedures performed with our Cryocare Surgical System, which we calculate using
two primary components. The first component is that we include the actual number of cryoablation
cases for which we perform the service element on behalf of the healthcare facility. In the second,
we compute a procedure case equivalent based on sales of our cryoablation disposable products by
using the expected disposable product usage for those sales. Accordingly, procedure growth is an
important metric to which we refer in order to measure the success of our strategy. In the past
several years, we have been successful in increasing the number of procedures on a year-over-year
basis. Most recently, in 2004 procedures increased 34.5 percent to 4,713 from 3,504 in 2003. In
2005, our objective is to increase the number of procedures at a significant rate which is
comparable to growth rates we have achieved historically.
In addition to being a key business metric, procedure growth is an important driver of revenue
growth, because a significant percentage of our revenues 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 towards seeking to increase
recurring sales of disposable supplies.
The factors driving interest in and utilization of cryoablation by urologists include:
|
|
|
increased awareness and acceptance of cryoablation by industry thought leaders; |
|
|
|
|
continued publication of clinical follow up data on the effectiveness of cryoablation,
including recently published 10-year data resulting from a study conducted by an affiliate
of Roper Hospital in Charleston, South Carolina; |
15
|
|
|
increased awareness among patients of cryoablation and the minimally invasive nature of
cryablation treatment and the comparable outcome as compared to radical prostatectomy; |
|
|
|
|
the pricing of our treatment is comparable to other modalities (e.g., radical
prostatectomy) and is approximately half the cost of brachytherapy; |
|
|
|
|
the effectiveness of our dedicated cryoablation sales force; and |
|
|
|
|
our continued expenditure of funds on patient education and advocacy. |
Results of Operations
Revenues and cost of revenues related to the following products and services for the three and
nine month periods ended September 30, 2005 and 2004 are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Nine Months Ended |
|
|
|
September 30, |
|
|
September 30, |
|
|
|
2005 |
|
|
2004 |
|
|
2005 |
|
|
2004 |
|
Revenues: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cryocare Surgical Systems |
|
$ |
132 |
|
|
$ |
320 |
|
|
$ |
404 |
|
|
$ |
570 |
|
Cryoablation disposable products and procedure fees |
|
|
6,653 |
|
|
|
5,743 |
|
|
|
19,690 |
|
|
|
16,752 |
|
Cardiac royalties (CryoCath) |
|
|
203 |
|
|
|
150 |
|
|
|
645 |
|
|
|
441 |
|
Erectile dysfunction products (Timm Medical) |
|
|
2,477 |
|
|
|
2,152 |
|
|
|
6,931 |
|
|
|
6,296 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
9,465 |
|
|
$ |
8,365 |
|
|
$ |
27,670 |
|
|
$ |
24,059 |
|
Cost of Revenues: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cryocare Surgical Systems |
|
$ |
107 |
|
|
$ |
26 |
|
|
$ |
405 |
|
|
$ |
108 |
|
Cryoablation disposable products and procedure fees |
|
|
3,701 |
|
|
|
3,509 |
|
|
|
11,513 |
|
|
|
10,035 |
|
Cardiac royalties (CryoCath) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Erectile dysfunction products (Timm Medical) |
|
|
763 |
|
|
|
739 |
|
|
|
2,300 |
|
|
|
2,678 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
4,571 |
|
|
$ |
4,274 |
|
|
$ |
14,218 |
|
|
$ |
12,821 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The table below summarizes revenues from the sales of cryoablation disposable products and
cryoablation procedure fees for the periods ended September 30, 2005 and 2004.
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.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Nine Months Ended |
|
|
|
September 30, |
|
|
September 30, |
|
|
|
2005 |
|
|
2004 |
|
|
2005 |
|
|
2004 |
|
Disposable products |
|
$ |
1,927 |
|
|
$ |
811 |
|
|
$ |
4,727 |
|
|
$ |
3,500 |
|
Procedure fees |
|
|
4,726 |
|
|
|
4,932 |
|
|
|
14,963 |
|
|
|
13,252 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
6,653 |
|
|
$ |
5,743 |
|
|
$ |
19,690 |
|
|
$ |
16,752 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
We recognize revenues from sales of Cryocare Surgical Systems, disposable cryoablation
products and other urological products when persuasive evidence of an arrangement exists, delivery
has occurred, the fee is fixed and determinable, and collectibility is reasonably assured.
We also contract with medical facilities to provide cryoablation services and for the use of
the Cryocare Surgical Systems in cryoablation treatments for which we charged a per-procedure fee.
The cryoablation services provided
generally consist of rental and transport of a Cryocare Surgical System, as well as the
services of a technician to assist the physician with the set-up, use and monitoring of the
equipment.
16
Cost of revenues consists 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. That portion of the
procedure fee remitted to the third-party service provider is charged to cost of revenues when the
procedure is performed and billed.
Research and development expenses are expensed when incurred and include expenses associated
with the design and development of new products as well as significant enhancements to existing
products. These expenses consist primarily of salaries and related benefits and overhead costs for
staff engaged in research and development activities, costs for materials and supplies used in
performing research and development activities, costs of clinical trials conducted for the purpose
of obtaining regulatory approval of our products, consulting and advisory fees for outside service
providers directly involved in research and development activities, and depreciation on equipment
used directly for research and development activities. Our research and development efforts are
periodically subject to significant non-recurring expenses and fees that can cause some variability
in our quarterly research and development expenses.
Sales and marketing expenses primarily consist of salaries, commissions and related benefits
and overhead costs for employees and activities in the areas of sales, marketing, ongoing research
and demonstration projects, our patient advocate group and customer service. Expenses associated
with advertising, trade shows, promotional and training costs related to marketing our products are
also classified as sales 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 reasonably be estimated.
Three Months Ended September 30, 2005 Compared to Three Months Ended September 30, 2004
Revenues. Revenues for the three months ended September 30, 2005 increased 13.2 percent to
$9.5 million compared to $8.4 million for the same period in 2004. The increase in revenues was
primarily attributable to growth in sales of disposables and procedure fees related to our
cryoablation business.
The number of cryoablation procedures performed, and related sales of disposable products used
in these procedures, increased 41.5 percent to 1,605 in the third quarter of 2005 from 1,134 in the
comparable period of 2004, while the related revenues increased 15.8 percent to $6.7 million in the
third quarter of 2005 from $5.7 million for the comparable period in 2004. Of the total procedures
performed during the three months ended September 30, 2005, 59.5 percent were those in which we
provided cryoablation services and 40.5 percent were from the
sale of cryoablation disposable products. This compares to 82.6 percent of cryoablation procedures and 17.4 percent for sales of
disposable cryoablation products during the three months ended September 30, 2004. 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 pain resulting from
metastases of cancer in the bone. 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 cancer, although cost of revenues are also lower.
CyoCath royalty revenues also increased 35.3 percent or $53,000 over the same period in 2004
while revenues from Cryocare Surgical Systems remained relatively flat due to our strategy of
promoting adoption of our
technology through an emphasis on growth in cryoablation procedures, rather than through sales
of capital equipment.
17
Sales of our Timm Medical product lines increased 15.1 percent to $2.5 million in the three
months ended September 30, 2005 from $2.2 million for the same period in 2004. This increase is
primarily due to product price increases and increased domestic sales
emphasized by our
erectile dysfunction sales force in 2005.
Cost of Revenues. Cost of revenues for the three months ended September 30, 2005 increased
7.0 percent to $4.6 million compared to $4.3 million for the same period in 2004. The increase in
cost of revenues resulted primarily from growth in sales of
cryoablation disposable products and procedure fees.
Cost of revenues related to our cryoablation disposable products and procedure
fees increased 5.5 percent to $3.7
million for the third quarter of 2005 from $3.5 million for the same period in 2004. This increase
was also driven by an increase in the number of cryoablation procedures for which we bill a
procedure fee and subcontract the service to third party service
provides at an additional cost.
During the three months ended September 30, 2005 substantially all of our
cryoablation procedures that require a technician were performed by third party service providers
at an additional cost.
Gross Margins. Gross margins on revenues increased to 51.7 percent for the three months ended
September 30, 2005 compared to 48.9 percent for the same period in 2004. The positive trend in
gross margins was related to factors including continued reductions in manufacturing costs for our
cryoablation disposable products as well as a 18.7 percent decline in the average fee we paid to third parties
to provide cryoablation procedures on our behalf, partially offset by an increase in cryoablation
procedures where we contracted with third parties to perform the procedures. Gross margins for our
Timm Medical product lines increased due to product price increases, higher domestic sales of
erectile dysfunction products and production cost reductions.
Research and Development Expenses. Research and development expenses for the three months
ended September 30, 2005 were unchanged at $0.4 million compared to the comparable period in 2004.
As a percentage of revenues, research and development expenses decreased to 4.6 percent from 5.0
percent during the three months ended September 30, 2004.
Sales and Marketing Expenses. Sales and marketing expenses for the three months ended
September 30, 2005 increased 13.2 percent to $4.1 million as compared to $3.6 million for the same
period in 2004. The increase in sales and marketing expenses is primarily due to an increase in
staffing costs of $0.3 million and an increase in advertising and trade show costs of $0.1 million.
These cost increases correspond with the increase in revenue and are consistent with our objective
of increasing the utilization of cryoablation systems and our
cryoablation disposable products by
urologists and interventional radiologists.
General and Administrative Expenses. General and administrative expenses for the three months
ended September 30, 2005 increased 15.1 percent to $3.9 million as compared to $3.4 million for the
same period in 2004. The increase resulted from a $0.3 million increase in legal fees related to
ongoing SEC and DOJ investigations, accounting and consulting costs related to Sarbanes-Oxley
compliance and other audit and tax compliance, as well as $0.5 million of liquidated damages
related to the delay in the registration of our common stock issued in our March 2005 private
placement.
Interest
Income (Expense), Net. Interest income (expense), net, for the three months ended September 30, 2005 was
$0.6 million compared to $73,000 for the same period in 2004. Interest income (expense), net for the three
months ended September 30, 2005 includes $0.5 million in negative interest expense recorded in connection
with the change in the fair value of common stock warrants issued in connection with our private
placement in March 2005. This represents the decrease in the fair value of the
warrants from June 30, 2005. Interest income (expense), net in the 2005 period also 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 the net proceeds from our March 2005 private
placement.
Net Loss. Net loss for the three months ended September 30, 2005 was $2.9 million or $0.10
per basic and diluted share on 30.1 million weighted average shares outstanding, compared to a net
loss of $19.3 million, or $0.80 per basic and diluted share on 24.2 million weighted average shares
outstanding for the same period in 2004.
18
Nine Months Ended September 30, 2005 Compared to Nine Months Ended September 30, 2004
Revenues. Revenues for the nine months ended September 30, 2005 increased 15.0 percent to
$27.7 million compared to $24.1 million in 2004. The revenue increase primarily resulted from the
increase in the number of cryoablation procedures performed, and related sales of disposable
products used in these procedures in the nine months ended September 30, 2005. Procedures
increased 35.3 percent to 4,717 for the nine months ended September 30, 2005 from 3,487 in the
comparable period of 2004, while the related revenues increased by 17.5 percent to $19.7 million
from $16.8 million for the comparable period in 2004. Of the total procedures performed during the
nine months ended September 30, 2005, 63.9 percent were those for which we provided cryoablation
services and 36.1 percent were from the sale of cryoablation
disposable products. This compares to
75.4 percent for cryoablation procedures and 24.6 percent for sales of disposable cryoablation
products during the nine months ended September 30, 2004. Contributing to the growth in revenues of
cryoablation products was an increase in sales to a market served by interventional radiologists,
treating tumors in the kidney, lung and liver, and pain resulting from metastases of cancer in the
bone. 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 cancer,
although cost of revenues are also lower. Cardiac royalty revenue increased 46.3 percent while the revenue from the sale of Cryocare
Surgical Systems remained relatively unchanged at $0.4 million for the nine months ended September
30, 2005 due to our strategy of promoting adoption of our technology
through an emphasis on growth in cryoablation procedures, rather
than through sales of capital equipment.
Sales of our Timm Medical product lines increased 10.1 percent to $6.9 million in the nine
months ended September 30, 2005 from $6.3 million for the same period in 2004. This increase is
primarily due to product price increases, increased domestic sales
emphasized by our
erectile dysfunction sales force in 2005.
Cost of Revenues. Cost of revenues for the nine months ended September 30, 2005 increased
10.9 percent to $14.2 million compared to $12.8 million for the same period in 2004 due primarily
to the growth of sales of cryoablation disposable products and
procedure fees. Cost of revenues related to our
cryoablation disposable products and procedure fees increased 14.7 percent to $11.5 million for 2005 from $10.0
million, for the same period in the 2004. The increase was driven by
an increase in the number of cryoablation procedures for which we
bill a procedure fee and we subcontract the service to
third party service providers at an additional cost partially offset
by a 16.3 percent decrease in
the amount per procedure we pay to the third party service providers. During the nine months ended
September 30, 2005 substantially all of our cryoablation procedures that require a technician were
performed by third party service providers.
Gross Margins. Gross margins on revenues increased to 48.6 percent for the nine months ended
September 30, 2005 compared to 46.7 percent for the same period in 2004. The positive trend in
gross margins was related to factors including continued reductions in manufacturing costs for our
cryoablation disposable products as well as a 16.3 percent decline in the average fee we paid to third parties
to provide cryoablation procedures on our behalf, partially offset by an increase in cryoablation
procedures where we contracted with third parties to perform the procedures. Gross margins for our
Timm Medical product lines increased due growth to product price increases and growth in domestic
sales of erectile dysfunction products.
Research and Development. Research and development expenses for the nine months ended
September 30, 2005 decreased 4.5 percent to $1.3 million compared to $1.4 million for the
comparable period in 2004. The decrease was primarily attributable to a reduction in consulting
and staffing costs initiated in our June 2004 cost reduction program. As a percentage of revenues,
research and development expenses decreased to 4.9 percent from 5.9 percent during the nine months
ended September 30, 2004.
Sales and Marketing. Sales and marketing expenses for the nine months ended September 30,
2005 declined 6.5 percent to $12.3 million as compared to $13.1 million for the same period in
2004. Driving the decrease were reductions in consulting costs and proctor fees and expenses which
decreased $0.6 million, and a decrease in severance costs of $0.2 million The term proctor fees
refers to the fees we pay physicians to train other physicians regarding how to use our
cryosurgical products.
General and Administrative Expenses. General and administrative expenses for the nine months
ended September 30, 2005 declined 16.4 percent to $11.8 million as compared to $14.1 million for
the same period in 2004. The decline resulted from a $2.8 million decrease in professional
services fees, primarily including legal fees
19
related to ongoing SEC and DOJ investigations and
accounting and consulting costs for Sarbanes-Oxley compliance and other audit and tax compliance.
These reductions were partially offset by $0.6 million in liquidated damages related to the delay
in registering our common stock issued in our March 2005 private placement, as well as a 2004
reduction of our bad debt provision of $0.4 million, which did not recur in 2005.
Impairment Charge. During the quarter ended September 30, 2004, we recorded $15.8 million in
impairment charges to write down the goodwill and amortizable intangibles in conjunction with Timm
Medical and our ownership interests in certain mobile prostate treatment businesses. The charge
represented the excess of the carrying value of these entities compared to their fair value, less
estimated costs to sell. With the completion of a $15.6 million private placement of our common
stock during the first quarter of 2005, management ceased actively marketing Timm Medical for sale
and reversed $0.6 million of estimated costs to sell that had been previously recorded as an
impairment charge.
Interest
Income (Expense), Net. Interest income (expense), net for the nine months ended September
30, 2005 was ($0.2) million compared to $0.2 million for the same period in 2004.
Interest income (expense), net for the nine months ended September 30, 2005 includes $0.6 million in
interest expense recorded in connection with the change in the fair value of common stock warrants
issued in connection with our private placement in March 2005. This interest expense represents the
net increase in the fair value of the warrants from March 11, 2005, the date of issuance. Interest income
(expense), net in the 2004 and 2005 period also includes interest income on a note receivable for
the sale 2003 of our urinary incontinence product and interest income earned from the investment of
the $14.6 million in net proceeds from our March 2005 private placement.
Minority Interests. Minority interests represent earnings attributable to minority investors
in the mobile prostate treatment businesses we acquired in 2002. During the fourth quarter of 2004
and the first quarter of 2005 we sold or dissolved a majority of these businesses. The businesses
dissolved or remaining during the first quarter of 2005 had no operations and therefore no minority
interest amounts were recorded in 2005.
Net Loss. Net loss for the nine months ended September 30, 2005 was $11.6 million or $0.40
per basic and diluted share on 29.0 million weighted average shares outstanding, compared to a net
loss of $33.5 million, or $1.38 per basic and diluted share on 24.3 million weighted average shares
outstanding for the same period in 2004.
Liquidity and Capital Resources
Since inception, we have incurred losses from operations and have reported negative cash
flows. As of September 30, 2005, we had an accumulated deficit of approximately $163.6 million and
cash and cash equivalents of approximately $11.1 million. On March 11, 2005, we issued 5,635,378
shares of our common stock, warrants to purchase an additional 1,972,374 shares of common stock at
$3.50 per share and warrants to purchase an additional 1,972,374 shares of common stock at $4.00
per share for aggregate gross cash proceeds of $15.6 million ($2.77 per share) less transaction
costs of $1.0 million, in a private placement financing.
While we will use these funds, and continued expense management efforts on those expenses that
are controllable, to finance on-going operations and cash flow needs, we do not expect to reach
break-even or cash flow positive in 2005, and we expect to continue to generate losses from
operations for the foreseeable future. These losses have resulted primarily from our continued
investment to educate physicians, gain acceptance within national
medical communities such as the American Urological Association,
establish and maintain reimbursement and create awareness among
patient advocacy groups and patients in general, all of which are
expenses necessary to create and build acceptance of our technology. We believe the success of our strategy is
reflected in the revenue growth for cryoablation, disposable products and procedure
fees. These revenues comprised 40.8 percent of total revenues in 2002 compared to 67.6 percent of
total revenues in 2004 representing a 75.4 percent increase from $12.6 million in 2002 to $22.1
million in 2004. For the nine months ended September 30, 2005, such revenues accounted for 71.2% of
total revenues.
While we expect these losses to decline over time, our cash use from quarter to quarter may
fluctuate, due to timing issues, investments in inventory and the costs related to ongoing
investigations into our historical accounting and financial reporting and regulatory compliance
discussed below. Regulators may fine us, or we may agree to make one or more settlement payments in
order to resolve the matters under investigation. We will also
continue to incur significant costs
under our obligations to indemnify our former officers and former directors in connection with
those investigations.
20
For the nine months ended September 30, 2005 and the year ended December 31, 2004, we incurred
$4.0 million and $7.1 million, respectively, in legal, audit and accounting support fees related to
these matters, including $0.8 million and $2.3 million, respectively, related to our efforts to
achieve compliance with the internal control reporting requirements of Section 404 of the
Sarbanes-Oxley Act. We also face large cash expenditures in the future related to past due state
and local tax obligations, for which we estimated and accrued $3.4 million as of September 30,
2005. We currently are in negotiations with various states to resolve past due taxes. However,
there is no assurance that these obligations will be reduced or that we will be allowed to pay the
amounts due over an extended period of time. During the fourth quarter of 2005, we expect to pay $1
million to our excess insurance carrier pursuant to a settlement
agreement anticipated to be entered into during
November 2005. We also expect to pay $750,000 upon the finalization of the proposed settlement with
the SEC.
We 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 the physicians usage of our technology in the treatment of prostate, lung and liver
cancers and in the management of pain from bone metastases. Such costs will be reported as current
period charges under generally accepted accounting principles.
We will use existing cash reserves and the net proceeds from the $15.6 million private
placement of our common stock described above along with continued expense management efforts to
finance our projected operating and cash flow needs. In addition, we recently entered into a
one-year credit agreement with Silicon Valley Bank, pursuant to which we may borrow up to an amount
not to exceed the lesser of: (i) $4 million; or (ii) amounts available under the Borrowing Base.
The Borrowing Base is (a) 80% of our eligible accounts receivable, plus (b) the lesser of 30% of
the value of our eligible inventory or $500,000. If we do not generate positive cash flows from
operations we may need to raise additional capital which may not be available on terms acceptable
to us, or at all. Any additional equity financing may be dilutive to stockholders, and debt
financing, if available, may involve interest expense and restrictive covenants.
See We face risks relating to our liquidity and we may never reach or maintain profitability
below under Risks Related to Our Business.
Risks Related to Our Business
The risks and uncertainties described below are not the only ones we face. For information
regarding other risks related to our business, please see Risks Related to Our Business in our
Annual Report on Form 10-K for the fiscal year ended December 31, 2004, as amended. Furthermore,
additional risks and uncertainties not presently known to us or that we currently deem immaterial
may also impair our operations. The occurrence of any of these risks could harm our business. In
that case, the trading price of our common stock could decline, and you may lose all or part of
your investment.
We face risks related to investigations by the SEC and DOJ.
As previously reported, the SEC and the DOJ are conducting investigations into allegations
that we and certain of our current and former officers and directors issued, or caused to be
issued, false and misleading statements regarding our financial results for 2001 and 2002 and
related matters, including whether we prematurely recognized revenue from the sale of Cryocare
systems and improperly delayed posting of expenses. Although we have fully cooperated with these
governmental agencies in these matters and intend to continue to fully cooperate, these
agencies may determine we have violated federal securities laws. We cannot predict when these
investigations will be completed or their outcomes. If it is determined that we have violated
federal securities laws or other laws or regulations, we may face sanctions, including, but not
limited to, significant monetary penalties and injunctive relief.
21
In addition, we are generally obliged under indemnification agreements to the extent permitted
by law, to pay the legal and other expenses for our directors and officers who are named defendants
in legal proceedings related to their service.
Our management members have spent considerable time and effort dealing with internal and external
investigations.
In addition to the challenges of the SEC investigation, the DOJ investigation, a shareholder
class-action and a derivative lawsuit and other legal proceedings described in our Annual Report on
Form 10-K filed on March 16, 2005, our management members have spent considerable time and effort
dealing with internal and external investigations involving our previous internal controls,
accounting policies and procedures, disclosure controls and procedures and corporate governance
policies and procedures. The significant time and effort spent has adversely affected our
operations and may continue to do so in the future.
We face risks relating to our liquidity and we may never reach or maintain profitability
We have incurred annual operating losses each year since our inception. As of September 30,
2005, our accumulated deficit was approximately $163.6 million and cash equivalents of $11.1
million. It is possible that we will not generate sufficient revenues from product sales and
service revenues to achieve profitability. Even if we do achieve significant revenues from our
products sales and service revenues, we expect that operating expenses will result in significant
operating losses over the next several quarters, as we, among other things:
|
|
|
incur costs related to legal proceedings, including ongoing government investigations; |
|
|
|
|
attempt to get our stock relisted on a national exchange; |
|
|
|
|
comply with changes in generally accepted accounting principles and include employee
based stock option charges in our consolidated statement of operations in 2006; |
|
|
|
|
comply with the increasing complexities and costs of being a public company, such as
Sarbanes-Oxley compliance |
|
|
|
|
expand our sales and marketing activities as we attempt to gain market share for our
Cryocare Surgical System; and |
|
|
|
|
continue our research and development efforts to improve our existing products and
develop newer products. |
We
will need to significantly increase the revenues we receive from
sales of cryoablation disposable products and
procedure fees as a result of these operating expenses. We may be unable to do so, and therefore, may
not achieve profitability. Even if we do achieve profitability, we cannot be certain that we will
be able to sustain or increase profitability on a quarterly or annual basis.
If we do not generate positive cash flows from operations we may need to raise additional
capital which may not be available on terms acceptable to us, or at all. Any additional equity
financing may be dilutive to stockholders, and debt financing, if available, may involve interest
expense and restrictive covenants.
We have incurred significant expenses related to legal, audit and accounting support fees
related to these matters, including expenses related to our efforts to achieve compliance with the
internal control reporting requirements of Section 404 of the Sarbanes-Oxley Act. We also face
large cash expenditures in the future related to past due state and local tax obligations. During
the fourth quarter of 2005, we expect to pay $1 million to our excess insurance carrier pursuant to
a settlement agreement expected to be entered into during November 2005. We also expect to pay $750,000 upon the
finalization of the proposed settlement with the SEC.
For a further description of the nature of the risks relating to our liquidity see, Part I,
Item 2 Managements Discussion and Analysis of Financial Condition and Results of Operations
Liquidity and Capital Resources.
22
Our success will depend on our ability to attract and retain key personnel.
In order to execute our business plan, we need to attract, retain and motivate a significant
number of highly qualified managerial, technical, financial and sales personnel. If we fail to
attract and retain skilled scientific and marketing personnel, our research and development and
sales and marketing efforts will be hindered. Our future success depends to a significant degree
upon the continued services of key management personnel, including Craig T. Davenport, our Chief
Executive Officer, William J. Nydam, our President and Chief Operating Officer, and Michael R.
Rodriguez, our Senior Vice President, Finance and Chief Financial Officer. None of our key
management personnel is covered by an insurance policy of which we are the beneficiary.
Future sales of shares of our common stock may negatively affect our stock price.
Future sales of our common stock, including shares issued upon the exercise of outstanding
options and warrants or hedging or other derivative transactions with respect to our stock, could
have a significant negative effect on the market price of our common stock. These sales also might
make it more difficult for us to sell equity securities or equity-related securities in the future
at a time and price that we would deem appropriate. We had an aggregate of 30,073,519 shares of
common stock outstanding as of September 30, 2005, which included 5,635,378 shares of our common
stock that we issued on March 11, 2005 in connection a financing described in the Form 8-K that we
filed on March 16, 2005. Investors in that financing also received warrants to purchase an
aggregate of 1,972,374 shares of our common stock at an exercise price of $3.50 per share and
1,972,374 shares of our common stock at an exercise price of $4.00 per share. We entered into a
registration rights agreement in connection with the financing pursuant to which we agreed to
register for resale by the investors the shares of common stock issued and the registration statement became
effective on September 28, 2005
and sales of shares covered by the
registration statement could
have a significant negative effect on
the market price of our stock.
Our common stock was delisted from the Nasdaq Stock Market and, as a result, trading of our common
stock has become more difficult.
Our common stock was delisted from The Nasdaq Stock Market on January 16, 2003 because of our
failure to keep current in filing our periodic reports with the SEC. Trading was conducted in the
over-the-counter market in the so-called pink sheets. Effective October 21, 2005 we began trading
on the OTC Bulletin Board (OTC BB) so our shares can be electronically traded. Trading on the
OTC BB could result in lower prices and larger spreads in the bid and ask prices for shares of our
common stock as well as lower trading volume. We have been in discussions with Nasdaq regarding the
relisting of our common stock. We hope that our common stock will be relisted with either the
Nasdaq SmallCap Market or the Nasdaq National Market System, but we cannot assure you that our
common stock will be relisted within any particular time period, or at all. As noted below, we may
effectuate a reverse stock split in order to qualify our stock for relisting.
As a result of the delisting of our common stock from The Nasdaq Stock Market, our common
stock has become subject to the penny stock regulations, including Rule 15g-9 under the
Securities Exchange Act of 1934. That rule imposes additional sales practice requirements on
broker-dealers that sell low-priced securities to persons other than established customers and
institutional accredited investors. For transactions covered by this rule, a broker-dealer must
make a special suitability determination for the purchaser and have received the purchasers
written consent to the transaction prior to sale. Consequently, the rule may affect the ability of
broker-dealers to sell our common stock and affect the ability of holders to sell their shares of
our common stock in the secondary market. To the extent our
common stock remains subject to the penny stock regulations, the market liquidity for the
shares will be adversely affected.
23
In order to qualify our stock for national exchange relisting, we may effectuate a reverse stock
split, which could adversely affect our stockholders.
In order to qualify our stock for relisting, we may effectuate a reverse stock split. We
believe that we currently satisfy all of the objective criteria for relisting on AMEX, and we
believe that we currently satisfy all of the objective criteria for relisting on the Nasdaq
SmallCap Market and the Nasdaq National Market System, except for the minimum bid price requirement
applicable to the Nasdaq National Market System. AMEX requires a minimum bid price of $3.00, the
Nasdaq SmallCap Market requires a minimum bid price of $4.00 and the Nasdaq National Market System
requires a minimum bid price of $5.00. As of September 30, 2005, the closing price for our common
stock as reported on the pink sheets was $3.25 per share. Of course, we cannot predict whether
this share price will be maintained or increased in the future.
Any reverse stock split requires the prior approval of our stockholders at a stockholders
meeting, because our charter prohibits stockholder action by written consent. On August 30, 2005,
our stockholders held a Special Meeting and approved by a vote of more than 70% to allow our Board
of Directors to effectuate a reserve stock split should it be warranted. The approval allowed for
the combination of any whole number of shares of common stock between and including two and five
into one share of common stock, i.e., each of the following combination ratios: one for two, one
for three, one for four and one for five. If our board decides to proceed with the reverse stock
split, then the board will determine the exact ratio within the range described in the previous
sentence. If the board does not implement a reverse stock split prior to the one-year anniversary
of the special stockholders meeting, then stockholder approval again would be required prior to
implementing any reverse stock split.
In many instances historically the markets have reacted negatively to the effectuation of a
reverse stock split. We cannot assure you that our stock will not be negatively affected if our
board decides to proceed with a reverse stock split. However, we believe that our circumstances and
rationale for the reverse stock split differentiate us from many other companies that have
effectuated reverse stock splits. Among other things, we would be effectuating a reverse stock
split to qualify our common stock for listing, whereas many other companies have effectuated
reverse stock splits to avoid delisting in the face of dire financial or operational circumstances.
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 receivable, accounts
payable and accrued liabilities. As of September 30, 2005, the carrying values of our financial
instruments approximated their fair values. Our policy 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 Securities and Exchange Commissions 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 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.
24
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 2005 that has materially affected, or is reasonably
likely to materially affect, our internal control over financial reporting.
PART II OTHER INFORMATION
Item 1. Legal Proceedings
We incorporate by reference the information contained in Note 9 Commitments and
Contingencies-Legal Matters to the condensed consolidated financial statements included above in
Item 1 of Part I.
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
We held a Special Meeting of Stockholders on August 30, 2005. At the Special Meeting, our
stockholders authorized our board of directors in its discretion to effectuate an amendment to our
Restated Certificate of Incorporation to effect a reverse stock split of our common stock, at an
exchange ratio ranging from one-to-two to one-to-five, which the specific ratio to be determined by
the board of directors.
The vote to approve this item was as follows:
|
|
|
|
|
|
|
Number of |
|
|
|
Shares |
|
For |
|
|
21,182,264 |
|
Against |
|
|
819,707 |
|
Abstain |
|
|
66,570 |
|
Item 5. Other Information
None.
25
Item 6. Exhibits
|
|
|
Exhibit |
|
|
No. |
|
Description |
2.1(1)
|
|
Agreement and Plan of Reorganization dated February 21, 2002, by and among the Company,
Technologies, Inc., TMT Acquisition Corporation and certain stockholders of Timm Medical
Technologies, Inc. Certain schedules and other attachments to this exhibit were omitted.
We agree to furnish supplementally a copy of any omitted schedules or attachments to the
Commission upon request. |
|
|
|
2.2(2)
|
|
Agreement and Plan of Merger dated September 30, 1999, by and among the Company, Advanced
Medical Procedures, Inc., Advanced Medical Procedures, L.L.C., Gary M. Onik, M.D., Robert
F. Byrnes and Jerry Anderson. Certain schedules and other attachments to this exhibit were
omitted. We agree to furnish supplementally a copy of any omitted schedules or attachments
to the Commission upon request. |
|
|
|
2.3(3)
|
|
Asset Purchase Agreement, dated February 6, 2002, by and between the Company and Gary M.
Onik, M.D. Certain schedules and other attachments to this exhibit were omitted. We agree
to furnish supplementally a copy of any omitted schedules or attachments to the Commission
upon request. |
|
|
|
2.4(3)
|
|
Asset Purchase Agreement dated May 28, 2002, by and among the Company and Cryomedical
Sciences, Inc. Certain schedules and other attachments to this exhibit were omitted. We
agree to furnish supplementally a copy of any omitted schedules or attachments to the
Commission upon request. |
|
|
|
2.5(4)
|
|
Partnership and Limited Liability Company Membership Interest Purchase Agreement, dated as
of August 12, 2002, by and among Endocare, Inc. and U.S. Medical Development, Inc.,
U.S.M.D., Ltd. and U.S.M.D. I, L.L.C. Certain schedules and exhibits referenced in this
exhibit have been omitted. We agree to furnish supplementally a copy of any omitted
schedules or attachments to the Commission upon request. |
|
|
|
2.6(5)
|
|
Amendment No. 1 to Partnership and Limited Liability Company Membership Interest Purchase
Agreement, dated as of August 12, 2002, by and among Endocare, Inc. and U.S. Medical
Development, Inc., U.S.M.D., Ltd. and U.S.M.D. I, L.L.C. |
|
|
|
2.7(6)
|
|
Agreement of Purchase and Sale, dated as of April 7, 2003, by and among American Medical
Systems, Inc., the Company and Timm Medical Technologies, Inc. |
|
|
|
2.8(7)*
|
|
Asset Purchase and Technology License Agreement, dated as of April 29, 2003, by and
between the Company and CryoCathTechnologies Inc. |
|
|
|
2.9(8)
|
|
Agreement of Purchase and Sale, dated as of October 15, 2003, by and between SRS Medical
Corp. and Timm Medical Technologies, Inc. |
|
|
|
2.10(9)
|
|
Amendment No. 2 to Partnership and Limited Liability Company Membership Interest Purchase
Agreement, dated as of February 27, 2004, by and among Endocare, Inc. and U.S. Medical
Development, Inc., U.S.M.D., Ltd. and U.S.M.D. I, L.L.C. |
|
|
|
2.11(9)
|
|
Service Fee Agreement, dated as of February 26, 2004, by and among Endocare, Inc. and the
Limited Partners of Mid-America Cryotherapy, L.P. |
|
|
|
2.12(9)
|
|
First Amendment to Agreement of Purchase and Sale, dated as of March 25, 2004, by and
between SRS Medical Corp. and Timm Medical Technologies, Inc. |
|
|
|
2.13(10)
|
|
First Amendment to Asset Purchase Agreement, dated as of August 18, 2004, by and between
Endocare, Inc. and Gary Onik, M.D. |
|
|
|
3.1(2)
|
|
Certificate of Amendment of Restated Certificate of Incorporation of the Company. |
26
|
|
|
Exhibit |
|
|
No. |
|
Description |
3.2(2)
|
|
Certificate of Designation of Series A Junior Participating Preferred Stock of the Company. |
|
|
|
3.3(2)
|
|
Restated Certificate of Incorporation. |
|
|
|
3.4(11)
|
|
Amended and Restated Bylaws of the Company. |
|
|
|
4.1(12)
|
|
Form of Stock Certificate. |
|
|
|
4.2(13)
|
|
Form of Series A Warrant. |
|
|
|
4.3(13)
|
|
Form of Series B Warrant. |
|
|
|
4.4(14)
|
|
Rights Agreement, dated as of 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(15)
|
|
Amendment No. 1 to Rights Agreement, dated as of September 24, 2005, between the Company
and U.S. Stock Transfer Corporation. |
|
|
|
10.1(16)
|
|
Description of director compensation, as amended on September 14, 2005 |
|
|
|
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. |
|
|
|
* |
|
Certain confidential portions of this exhibit were omitted and provided separately to the
SEC pursuant to a request for confidential treatment. |
|
|
|
Management contract or compensatory plan or arrangement |
|
(1) |
|
Previously filed as exhibits to our Form 8-K filed on March 5, 2002. |
|
(2) |
|
Previously filed as exhibits to our Registration Statement on Form S-3 filed on September
20, 2001. |
|
(3) |
|
Previously filed as exhibits to our Form 10-Q filed on August 14, 2002. |
|
(4) |
|
Previously filed as exhibits to our Form 8-K filed on August 16, 2002. |
|
(5) |
|
Previously filed as an exhibit to our Form 8-K filed on October 15, 2002. |
|
(6) |
|
Previously filed as an exhibit to our Form 8-K filed on April 22, 2003. |
|
(7) |
|
Previously filed as an exhibit to our Form 8-K filed on April 29, 2003. |
|
(8) |
|
Previously filed as an exhibit to our Form 8-K filed on October 20, 2003. |
|
(9) |
|
Previously filed as an exhibit to our Form 10-Q filed on May 10, 2004. |
27
|
|
|
(10) |
|
Previously filed as an exhibit to our Form 10-Q filed on November 9, 2004. |
|
(11) |
|
Previously filed as an exhibit to our Form 10-K filed on March 15, 2004. |
|
(12) |
|
Previously filed as an exhibit to our Form 10-K for the year ended December 31, 1995. |
|
(13) |
|
Previously filed as an exhibit to our Form 8-K filed on March 16, 2005. |
|
(14) |
|
Previously filed as an exhibit to our Form 8-K filed on September 3, 1999. |
|
(15) |
|
Previously filed as an exhibit to our Form 8-K filed on September 28, 2005. |
|
(16) |
|
Previously filed as an exhibit to our Form 8-K/A filed on September 16, 2005. |
28
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 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 9, 2005
29
EXHIBIT INDEX
|
|
|
Exhibit |
|
|
No. |
|
Description |
2.1(1)
|
|
Agreement and Plan of Reorganization dated February 21, 2002, by and among the Company,
Technologies, Inc., TMT Acquisition Corporation and certain stockholders of Timm Medical
Technologies, Inc. Certain schedules and other attachments to this exhibit were omitted.
We agree to furnish supplementally a copy of any omitted schedules or attachments to the
Commission upon request. |
|
|
|
2.2(2)
|
|
Agreement and Plan of Merger dated September 30, 1999, by and among the Company, Advanced
Medical Procedures, Inc., Advanced Medical Procedures, L.L.C., Gary M. Onik, M.D., Robert
F. Byrnes and Jerry Anderson. Certain schedules and other attachments to this exhibit were
omitted. We agree to furnish supplementally a copy of any omitted schedules or attachments
to the Commission upon request. |
|
|
|
2.3(3)
|
|
Asset Purchase Agreement, dated February 6, 2002, by and between the Company and Gary M.
Onik, M.D. Certain schedules and other attachments to this exhibit were omitted. We agree
to furnish supplementally a copy of any omitted schedules or attachments to the Commission
upon request. |
|
|
|
2.4(3)
|
|
Asset Purchase Agreement dated May 28, 2002, by and among the Company and Cryomedical
Sciences, Inc. Certain schedules and other attachments to this exhibit were omitted. We
agree to furnish supplementally a copy of any omitted schedules or attachments to the
Commission upon request. |
|
|
|
2.5(4)
|
|
Partnership and Limited Liability Company Membership Interest Purchase Agreement, dated as
of August 12, 2002, by and among Endocare, Inc. and U.S. Medical Development, Inc.,
U.S.M.D., Ltd. and U.S.M.D. I, L.L.C. Certain schedules and exhibits referenced in this
exhibit have been omitted. We agree to furnish supplementally a copy of any omitted
schedules or attachments to the Commission upon request. |
|
|
|
2.6(5)
|
|
Amendment No. 1 to Partnership and Limited Liability Company Membership Interest Purchase
Agreement, dated as of August 12, 2002, by and among Endocare, Inc. and U.S. Medical
Development, Inc., U.S.M.D., Ltd. and U.S.M.D. I, L.L.C. |
|
|
|
2.7(6)
|
|
Agreement of Purchase and Sale, dated as of April 7, 2003, by and among American Medical
Systems, Inc., the Company and Timm Medical Technologies, Inc. |
|
|
|
2.8(7)*
|
|
Asset Purchase and Technology License Agreement, dated as of April 29, 2003, by and
between the Company and CryoCathTechnologies Inc. |
|
|
|
2.9(8)
|
|
Agreement of Purchase and Sale, dated as of October 15, 2003, by and between SRS Medical
Corp. and Timm Medical Technologies, Inc. |
|
|
|
2.10(9)
|
|
Amendment No. 2 to Partnership and Limited Liability Company Membership Interest Purchase
Agreement, dated as of February 27, 2004, by and among Endocare, Inc. and U.S. Medical
Development, Inc., U.S.M.D., Ltd. and U.S.M.D. I, L.L.C. |
|
|
|
2.11(9)
|
|
Service Fee Agreement, dated as of February 26, 2004, by and among Endocare, Inc. and the
Limited Partners of Mid-America Cryotherapy, L.P. |
|
|
|
2.12(9)
|
|
First Amendment to Agreement of Purchase and Sale, dated as of March 25, 2004, by and
between SRS Medical Corp. and Timm Medical Technologies, Inc. |
30
|
|
|
Exhibit |
|
|
No. |
|
Description |
2.13(10)
|
|
First Amendment to Asset Purchase Agreement, dated as of August 18, 2004, by and between
Endocare, Inc. and Gary Onik, M.D. |
|
|
|
3.1(2)
|
|
Certificate of Amendment of Restated Certificate of Incorporation of the Company. |
|
|
|
3.2(2)
|
|
Certificate of Designation of Series A Junior Participating Preferred Stock of the Company. |
|
|
|
3.3(2)
|
|
Restated Certificate of Incorporation. |
|
|
|
3.4(11)
|
|
Amended and Restated Bylaws of the Company. |
|
|
|
4.1(12)
|
|
Form of Stock Certificate. |
|
|
|
4.2(13)
|
|
Form of Series A Warrant. |
|
|
|
4.3(13)
|
|
Form of Series B Warrant. |
|
|
|
4.4(14)
|
|
Rights Agreement, dated as of 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(15)
|
|
Amendment No. 1 to Rights Agreement, dated as of September 24, 2005, between the Company
and U.S. Stock Transfer Corporation. |
|
|
|
10.1(16)
|
|
Description of director compensation, as amended on September 14, 2005. |
|
|
|
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. |
|
|
|
* |
|
Certain confidential portions of this exhibit were omitted and provided separately to the
SEC pursuant to a request for confidential treatment. |
|
|
|
Management contract or compensatory plan or arrangement |
|
(1) |
|
Previously filed as exhibits to our Form 8-K filed on March 5, 2002. |
|
(2) |
|
Previously filed as exhibits to our Registration Statement on Form S-3 filed on September
20, 2001. |
|
(3) |
|
Previously filed as exhibits to our Form 10-Q filed on August 14, 2002. |
|
(4) |
|
Previously filed as exhibits to our Form 8-K filed on August 16, 2002. |
|
(5) |
|
Previously filed as an exhibit to our Form 8-K filed on October 15, 2002. |
|
(6) |
|
Previously filed as an exhibit to our Form 8-K filed on April 22, 2003. |
31
|
|
|
(7) |
|
Previously filed as an exhibit to our Form 8-K filed on April 29, 2003. |
|
(8) |
|
Previously filed as an exhibit to our Form 8-K filed on October 20, 2003. |
|
(9) |
|
Previously filed as an exhibit to our Form 10-Q filed on May 10, 2004. |
|
(10) |
|
Previously filed as an exhibit to our Form 10-Q filed on November 9, 2004. |
|
(11) |
|
Previously filed as an exhibit to our Form 10-K filed on March 15, 2004. |
|
(12) |
|
Previously filed as an exhibit to our Form 10-K for the year ended December 31, 1995. |
|
(13) |
|
Previously filed as an exhibit to our Form 8-K filed on March 16, 2005. |
|
(14) |
|
Previously filed as an exhibit to our Form 8-K filed on September 3, 1999. |
|
(15) |
|
Previously filed as an exhibit to our Form 8-K filed on September 28, 2005. |
|
(16) |
|
Previously filed as an exhibit to our Form 8-K/A filed on September 16, 2005. |
32