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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-K
FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO
SECTIONS 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
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(Mark One)
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ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 |
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For the fiscal year ended December 31, 2005; or |
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TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 |
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For the Transition period
from to . |
Commission File Number 001-15063
Endocare, Inc.
(Exact name of registrant as specified in its charter)
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Delaware |
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33-0618093 |
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(State of incorporation)
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(I.R.S. Employer Identification No.) |
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201 Technology, Irvine, CA |
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92618 |
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(Address of principal executive offices)
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(Zip Code) |
Registrants telephone number, including area code:
(949) 450-5400
Securities registered pursuant to Section 12(b) of the
Act: None
Securities registered pursuant to Section 12(g) of the
Act:
Common Stock, $.001 par value
Rights to Purchase Shares of Series A Junior
Participating Preferred Stock
(Title of Class)
Indicate by check mark if the registrant
is a well-known seasoned issuer, as defined in Rule 405 of
the Securities
Act. Yes o No þ
Indicate by check mark if the registrant
is not required to file reports pursuant to Section 13 or
Section 15(d) of the
Act. Yes o No þ
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 if disclosure of
delinquent filers pursuant to Item 405 of
Regulation S-K is
not contained herein, and will not be contained, to the best of
the registrants knowledge, in definitive proxy or
information statements incorporated by reference in
Part III of this
Form 10-K or any
amendment to this
Form 10-K. þ
Indicate by check mark whether the
registrant is a large accelerated filer, an accelerated filer,
or a non-accelerated filer. See definition of accelerated
filer and large accelerated filer in
Rule 12b-2 of the
Exchange Act. (Check one):
Large Accelerated
Filer o Accelerated
Filer þ Non-Accelerated
Filer o
Indicate by check mark whether the
registrant is a shell company (as defined in
Rule 12b-2 of the
Exchange
Act). Yes o No þ
The aggregate market value of the common
stock of the Registrant held by non-affiliates as of
June 30, 2005 was approximately $106,443,528 (based on the
last sale price for shares of the Registrants common stock
as reported in the Pink Sheets for that date). Shares of common
stock held by each executive officer, director and holder of
10 percent or more of the outstanding common stock have
been excluded in that such persons may be deemed affiliates.
Exclusion of shares held by any person should not be construed
to indicate that such person possesses the power, direct or
indirect, to direct or cause the direction of management or
policies of the Registrant, or that such person is controlled by
or under common control with the Registrant.
There were 30,147,894 shares of the
Registrants common stock issued and outstanding as of
February 28, 2006.
DOCUMENTS INCORPORATED BY REFERENCE
Certain portions of the Definitive Proxy
Statement related to our 2006 Annual Meeting of Stockholders,
which Definitive Proxy Statement we expect to file under the
Securities Exchange Act of 1934, as amended, within
120 days of the end of our fiscal year ended
December 31, 2005, are incorporated by reference into
Part III of this Annual Report on
Form 10-K.
Certain exhibits filed with our prior
registration statements and
Forms 10-K, 8-K
and 10-Q are
incorporated herein by reference into Part IV of this
Annual Report on
Form 10-K.
Endocare, Inc.
Form 10-K
For the Fiscal Year Ended December 31, 2005
TABLE OF CONTENTS
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PART I
This Annual Report on
Form 10-K may
contain forward-looking statements that involve risks and
uncertainties. Such statements typically include, but are not
limited to, statements containing the words
believes, intends,
anticipates, expects, hopes,
estimates, should, could,
may, plans, planned and
words of similar import. Our actual results could differ
materially from any such forward-looking statements as a result
of the risks and uncertainties, including but not limited to
those set forth below in Risks Factors and in other
documents we file from time to time with the Securities and
Exchange Commission, including our Quarterly Reports on
Form 10-Q. Any
such forward-looking statements reflect our managements
opinions only as of the date of this Annual Report on
Form 10-K, and we
undertake no obligation to revise or publicly release the
results of any revisions to these forward-looking statements.
Readers should carefully review the risk factors set forth below
in Risks Factors and in other documents we file from
time to time with the Securities and Exchange Commission,
including our Quarterly Reports on
Form 10-Q.
AutoFreeze, CGC,
Cryocare®,
Cryocare CS, Cryocare Surgical
System®,
CryoDisc®,
CryoGrid,
CryoGuide®,
Direct Access,
Endocare®,
FastTrac®,
Integrated Ultrasound, SmartTemp, Targeted
Ablation, Targeted Ablation of the Prostate
TAP®,
Targeted Ablation Therapy
TAT®,
Targeted Cryoablation of the Prostate
TCAP®,
Targeted Cryoablation Therapy
TCAT®,
TEMPprobe®,
and Urethral Warmer are our trademarks. This Annual Report
on Form 10-K may
also include trademarks and trade names owned by other parties,
and all other trademarks and trade names mentioned in this
Annual Report on
Form 10-K are the
property of their respective owners.
Overview
We are a specialty medical device company focused on improving
patients lives through the development, manufacturing and
distribution of health care products for cryoablation. Our
strategy is to achieve a dominant position in the prostate and
renal cancer markets, further developing and increasing 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, while achieving
penetration across additional markets with our proprietary
cryosurgical technology. The term cryoablation
refers to the use of ice to destroy tissue, such as tumors, for
therapeutic purposes. The term cryosurgical
technology refers to technology relating to the use of ice
in surgical procedures, including cryoablation procedures.
Today, our FDA-cleared Cryocare Surgical System occupies a
growing position in the urological market for treatment of
prostate and renal cancer. Because of our initial concentration
on prostate and renal cancer, the majority of our sales and
marketing resources are directed toward the promotion of our
technology to urologists. In addition to selling our
cryosurgical disposal products to hospitals and mobile service
companies, we contract directly with hospitals and health care
payors for the use of our Cryocare Surgical System and
disposable products on a fee-for-service basis. We believe our
proprietary cryosurgical technologies have broad applications
across a number of surgical markets, including for the treatment
of tumors in the lung and liver, and the management of bone pain
caused by tumors. To that end, we employ a dedicated sales team
focused on selling percutaneous cryoablation procedures related
to kidney, liver, lung and bone cancer to interventional
radiology physicians throughout the United States. We intend to
continue to invest in resources to continue to penetrate the
interventional radiology and oncology markets and develop new
markets for our cryosurgical products and technologies,
particularly in the area of tumor ablation.
We were incorporated under the laws of the State of Delaware in
May 1994. We maintain our executive offices at
201 Technology Drive, Irvine, California 92618, and our
telephone number at that address is
(949) 450-5400.
Financial information regarding our financial condition and
results of operations can be found in a separate section of this
Annual Report on
Form 10-K,
beginning on page F-1.
1
Prostate Cancer/ Urology Market Background
The prostate is a walnut-size gland surrounding the male
urethra, located below the bladder and adjacent to the rectum.
Prostate cancer is one or more malignant tumors that begin most
often in the periphery of the gland and, like other forms of
cancer, may spread beyond the prostate to other parts of the
body. If left untreated, prostate cancer can metastasize to the
lung or bone and potentially other sites, resulting in death.
The number of men diagnosed with prostate cancer has risen
steadily since 1980 and it is now the second most common cause
of cancer-related deaths among men in the United States. The
American Cancer Society estimated there would be 234,000 new
cases of prostate cancer diagnosed and 27,000 deaths associated
with the disease in the United States during 2006. Prostate
cancer incidence and mortality increase with age. Prostate
cancer is found most often in men who are over the age of 50.
According to the American Cancer Society, more than
65 percent of men diagnosed with prostate cancer are over
the age of 65. Incidence rates are higher in African American
men. In addition to age and race, other risk factors are linked
to prostate cancer, such as genetics, diet and exposure to
environmental toxins such as Agent Orange.
The dramatic increase in prostate cancer diagnoses has led to
heightened awareness of the disease, which in turn has led to
increased rates of testing and improved diagnostic methods. The
American Cancer Society recommends that men without symptoms,
risk factors and a life expectancy of at least 10 years
should begin regular annual medical exams at the age of 50, and
believes that physicians should offer, as a part of the exam,
the prostate-specific antigen, or PSA, blood test and a digital
rectal examination to detect any lumps in the prostate. The PSA
blood test determines the amount of prostate specific antigen
present in the blood. PSA is found in a protein secreted by the
prostate, and elevated levels of PSA can be associated with,
among other things, prostatitis, a non-cancerous inflammatory
condition, or a proliferation of cancer cells in the prostate.
Transrectal ultrasound tests and biopsies are typically
performed on patients with elevated PSA readings to confirm the
existence of cancer.
Approximately 90 percent of all prostate cancers diagnosed
in the United States are local or regional. Thus, approximately
211,000 patients are candidates for definitive local
therapies including cryoablation. In addition it is estimated
that approximately 18,000 patients in the United States
each year are diagnosed with recurrent prostate cancer following
previous radiation therapy. With the increasing utilization of
radiation therapy, primarily brachytherapy, for initial
treatment in prostate cancer, we believe that this number will
increase. For recurrent tumors that are detected while still
localized, we believe cryoablation is an appropriate procedure
with fewer side effects than salvage radical prostatectomy and
can be performed at a substantially lower cost to the medical
facility.
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Non-Cryosurgical Treatment Options |
Therapeutic alternatives for patients with prostate cancer have
been limited and these treatments can significantly impact the
patients quality of life. Current treatment options
include radical prostatectomy, radiation therapy, hormone or
other therapies, watchful waiting, and cryosurgery.
These options are evaluated using a number of criteria,
including the patients age, physical condition and stage
of the disease. Due to the slow progression of the disease,
however, the decision for treatment is typically based upon the
severity of the condition and the resulting quality of life.
Radical prostatectomy has been used for over 30 years and
is most often the therapy of choice due to the surgeons
high degree of confidence in surgically removing the cancerous
tissue. The procedure is dependent on the skill of the surgeon
and is often associated with relatively high incidence of
post-operative impotence and incontinence and can even result in
operative mortality. Radical prostatectomy often requires a
three- to five-day hospital stay for patient recovery and
therefore a higher cost to the medical facility than
cryoablation.
Radiation therapy for prostate cancer includes both external
radiation beam and interstitial radioactive seed therapies.
External beam radiation therapy emerged as one of the first
alternatives to radical prostatectomy; however, studies have
shown that the success rate of this procedure is not comparable
to that of radical prostatectomy. Interstitial radioactive seed
therapy, also referred to as brachytherapy, is the permanent
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placement of radioactive seeds in the prostate. Brachytherapy
has been shown to be most effective for localized tumors caught
in the early stage of disease development.
Other therapies, primarily consisting of hormone therapy and
chemotherapy, are used to slow the growth of cancer and reduce
tumor size, but are generally not intended to be curative. These
therapies are often used during advanced stages of the disease
to extend life and to relieve symptoms. Side effects of hormonal
drug therapy include increased development of breasts and other
feminine physical characteristics, hot flashes, impotence and
decreased libido. In addition, many hormone pharmaceuticals
artificially lower PSA levels in patients, which can interfere
with the staging of the disease and monitoring its progress.
Side effects of chemotherapy include nausea, hair loss and
fatigue. Drug therapy and chemotherapy require long-term,
repeated administration of medication on an outpatient basis.
Watchful waiting is recommended by physicians in
certain circumstances based upon the severity and growth rate of
the disease, as well as the age and life expectancy of the
patient. The aim of watchful waiting is to monitor the patient,
treat some of the attendant symptoms and determine when more
active intervention is required. Watchful waiting has gained
popularity among those patients refusing treatment due to side
effects associated with radical prostatectomy. Watchful waiting
requires periodic physician visits and PSA monitoring.
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The History of Cryosurgery |
Cryosurgery, freezing tissue to destroy tumor cells, was first
developed in the 1960s. During this period, the use of
cold probes, or cryoprobes, was explored as a method
to kill prostate tissue without resorting to radical
prostatectomy. Although effective in killing cancer cells, the
inability to control the amount of tissue frozen during the
procedure prevented broad use and development of cryosurgery for
prostate cancer. These initial limitations in the application of
cryosurgery continue to contribute to a lack of widespread
acceptance of the procedure today.
In the late 1980s, progress in ultrasound imaging allowed
for a revival in the use of cryosurgery. Using ultrasound, the
cryoprobe may be guided to the targeted tissue from outside the
body through a small incision. The physician activates the
cryoprobe and uses ultrasound to monitor the growth of ice in
the prostate as it is occurring. When the ice encompasses the
entire prostate, the probe is turned off. This feedback
mechanism of watching the therapy as it is administered allows
the physician more precise control during application.
Long term data suggest that prostate cryosurgery may be able to
deliver disease-free rates comparable to radical surgery and
radiation, but with the benefit of lower rates of incontinence
and mortality, shorter recovery periods and relatively minimal
complications.
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Endocare Cryosurgery Technology Development |
We have sought to continually develop our technology to increase
the safety and efficacy of our products. In 1996, we developed
our first generation eight-probe argon-based cryosurgical
system. Argon allows for room temperature gas to safely pass
through the cryoprobe to create a highly sculpted repeatable ice
ball. In 1997, we incorporated temperature-monitoring software
to allow for continual feedback from the thermocouple tips. In
1998, we launched our CryoGuide intraoperative planning
software, which allowed physicians better planning and targeting
technology for use during a procedure. In 2000, we launched our
2.4mm Direct Access cryoprobe and CryoGrid which we believe
shortened the time necessary to perform a procedure and added to
the safety and ease of the procedure. In 2002 we developed and
launched AutoFreeze, our innovative software technology that
provides computer-controlled automated freeze/thaw cycles. In
2003, we launched our second generation Cryocare Surgical
System, which we refer to as Cryocare CS, which
integrated all the past and latest technology, including an
on-board, integrated ultrasound device, into one complete system.
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Our System Solution: Cryocare CS |
We believe Cryocare CS is the most sophisticated cryosurgery
system currently available and combines the latest technology to
enhance the speed and effectiveness of our FDA-cleared
procedure. Exclusive features
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of the Cryocare CS include an on-board training module,
integrated color Doppler ultrasound designed specifically for
the needs of prostate cryosurgery, CryoGuide our patented
intraoperative planning module, and AutoFreeze our patented
treatment software that provides computer-controlled automated
freeze/thaw cycles based upon target endpoint temperatures and
continual feedback from the thermocouple tips.
The argon gas-based Cryocare CS accommodates up to eight
independently operated cryoprobes and six thermocouples to allow
physicians to monitor temperatures of tissue adjacent to the
prostate in real-time. Our proprietary suite of cryoprobes is
engineered to consistently produce sculpted ice conforming to
the unique anatomy of the prostate. Our vacuum-insulated
DirectAccess CryoProbes help deliver lethal ice in a
controllable and repeatable fashion. Our CryoGrid, which is
similar to a brachytherapy grid, is affixed to the ultrasound
stepper and aids the physician with placement of the cryoprobes
ensuring that ice formation and lethal temperatures occur where
necessary to destroy cancerous tissue but do not affect areas
where tissue damage could cause harm.
We believe cryosurgery is the first minimally invasive procedure
that urologists can perform independently. With radiation
therapies, urologists must refer the patient for treatment to a
radiation oncologist. Cryosurgery offers the urologist both the
opportunity to maintain continuity of patient care and to
generate additional revenue.
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Key Clinical Advantages of Our Cryocare CS System |
Cryocare CS provides the following significant clinical
advantages relative to other principal treatment options for
prostate cancer:
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High quality of life following treatment. Our minimally
invasive procedure offers patients a short recovery period for
prostate cancer therapy and may result in a lower incidence of
certain side effects, including incontinence. |
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Treatment of patients who have failed radiation therapy.
Patients who have failed radiation therapy have limited options.
Cryosurgery is an option that can be used to treat these
patients effectively with significantly fewer side effects than
radical surgery. |
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Treatment can be performed more than once. Regardless of
what therapy is chosen there is always a chance that the cancer
will recur. Unlike radiation therapy or surgery, cryosurgery can
be repeated without increased morbidity. |
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Focal or partial gland treatment. Focal cryoablation is a
prostate cancer treatment in which the ablation is confined to
the known tumor location, thereby sparing surrounding tissue. |
Marketing and Strategy
Our objective in urology is to establish cryosurgery as a
primary treatment option for prostate and renal cancers. Our
earlier commercial efforts were focused on direct-sales to
hospitals and distributor sales of these systems to third party
service providers who would provide systems and technicians to
hospitals where cryosurgical procedures were performed.
In 2003, we redirected our urology strategy away from attempting
to drive acceptance of cryoablation through sales of capital
equipment into the urology market. Our primary objective for the
urology portion of our business is now to grow market share,
measured in terms of procedures, by establishing cryosurgery as
a primary treatment option for prostate and renal cancers. In
2003, 2004 and 2005, we derived a significant percentage of our
revenues from recurring sales of disposable supplies used with
the Cryocare Surgical System.
A cryoablation procedure requires the necessary disposable
devices usually provided in the form of a kit. In addition to
the disposable devices, there is a service component.
Transportation and provision of equipment used in the procedure,
plus the services of a technician to assist the urologist with
use and monitoring of this
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equipment, comprise the service component of a cryosurgical
procedure. In addition to the use of a Cryocare Surgical System,
an ultrasound device is needed for visual monitoring of the
prostate and ice formation, unless our new Cryocare CS unit is
used, since it includes an on-board, integrated ultrasound unit.
Tanks of argon and helium gas are needed for freezing and
warming during the procedure. Frequently, this equipment is not
stored on site but is mobilized and brought into the hospital
for procedures by an independent third party.
For urology we typically sell the disposable devices to
hospitals either as part of a procedure fee or separately, that
is, without the service component. We also continue to sell our
Cryocare Surgical Systems both to hospitals and service
partners. For interventional radiology we will often place a
system with a new customer under our placement program for
purposes of generating additional procedure fees.
An important challenge we face in the prostate cancer market is
to overcome initial reluctance on the part of urologists to
embrace cryosurgery and to educate physicians so that they are
able to incorporate cryosurgery into their primary treatment
regimen. Part of this reluctance is due to clinical failures
experienced during earlier efforts to introduce the technology
by other companies. See above under The History of
Cryosurgery. In addition, we compete with other therapies
that have proven effective in treating prostate cancer. Over
30 years of clinical data exist documenting the safety and
efficacy of radical prostatectomy for prostate cancer. There are
20 years of clinical data supporting use of various forms
of radiation treatment options such as brachytherapy and beam
radiation treatments, which are used to treat over one third of
all prostate cancer cases each year in the United States.
We believe we have clinical advantages for many patients over
both the current most popular forms of treatment. While there
are long-term clinical data available on radical prostatectomy,
this treatment approach, typical of surgery in general, is
characterized by a long recovery period combined with a
relatively high incidence of side effects, including impotence
and urinary incontinence. The appeal of radiation as a treatment
alternative, particularly to patients, is that it is less
invasive than surgery. Like radiation, cryosurgery is less
invasive and therefore has potentially fewer side effects than
radical prostatectomy. Unlike radiation treatments, however,
cryosurgical treatments can be repeated on the same patient. In
fact, our initial clinical successes in prostate cancer
treatment were in treating patients who had failed radiation
therapy. We also believe that cryosurgery has significant
economic benefits for payers. These benefits include shorter
hospital stays for recovery and the reduced expense to a payer
for the cryosurgery procedure takes to perform as compared to
radical prostatectomy and many forms of nuclear medicine, long
term hormone treatment or radiation therapies.
Key elements in our strategy for overcoming the challenges we
face in establishing cryosurgery as a primary treatment option
for prostate cancer are:
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Increasing awareness in the urological community regarding the
clinical benefits of cryosurgery through our presence at major
technical meetings and trade shows, publication of numerous
scientific papers and articles on cryosurgery and formation of a
scientific advisory board to provide guidance and counsel to us
regarding clinical matters and physician education; |
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Conducting ongoing clinical studies to further demonstrate the
safety and efficacy of cryosurgery as a primary treatment of
cancer of the prostate, as well as its value in treating
prostate cancer patients who have failed radiation; |
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Conducting clinical studies to further demonstrate the safety
and efficacy of cryosurgery as a treatment for renal tumors
which is another important component of the urology market for
cryosurgery; |
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Creating a significant number of new practicing cryosurgeons
each year through our physician education program; |
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Ensuring that reimbursement for cryosurgery by Medicare and
other payors is appropriate given the costs and benefits of the
treatment; |
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Driving patient awareness through our
direct-to-consumer
advertising programs; and |
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Marketing our products to physicians and hospitals through our
direct sales force. |
5
Because of our initial concentration on prostate cancer, the
majority of our sales and marketing resources are directed
towards the promotion of cryoablation technology to urologists
for the treatment of prostate and renal cancer. We are also,
however, expanding the reach of our technology across a number
of other markets, including for ablation of tumors in the lung
and liver, as well as for managing pain related to metastatic
bone cancer. Procedures for treatment of these cancers are
typically performed percutaneously, using CT scanning
technology, and are done by interventional radiologists. In
order to better understand and address the distinct needs of
this new market, we have formed a dedicated sales team to work
in developing these opportunities for application of our
cryosurgical technology.
Key elements in our strategy to establish new markets for
cryosurgical treatment of tumors, specifically in the
interventional radiology and radiation oncology markets, are:
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Conducting numerous clinical studies to demonstrate the safety
and efficacy of cryosurgery as a primary treatment for lung and
liver tumors as well as for pain management of bone metastases; |
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Formation of a dedicated sales group focused on the
opportunities for cryosurgical treatment approaches in these new
markets; and |
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Continuing to enhance our Cryocare Surgical System to improve
its ease of use across a broad range of tissue ablation
applications. |
Consistent with the focus of our cryosurgical business on tumor
ablation in 2003, we made the decision to divest or discontinue
certain product lines unrelated to this strategy. In April 2003
we sold the manufacturing rights to SurgiFrost, a product we had
developed for treatment of cardiac arrhythmia, to CryoCath. Part
of this transaction included licensing our technology and
intellectual property rights related to cryosurgical
applications in the cardiology market. As part of this
transaction, we sold all inventory and fixed assets related to
the SurgiFrost line. In addition, we made the decision in early
2003 to discontinue development and clinical testing of our
Horizon Prostatic Stent, designed for treatment of benign
prostate hyperplasia, also known as BPH or prostate enlargement.
Lastly, in February 2006 we disposed of our Timm Medical
Technologies, Inc. subsidiary to Plethora Solutions Holdings plc.
Products
We currently market the following products:
Prostate and Renal Cancer:
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Cryocare Surgical System A cryosurgical system with
eight cryoprobe capability. |
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Cryocare CS System A Cryocare Surgical System with
onboard ultrasound. |
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CryoGuide A computerized cryoprobe placement,
simulation and guidance system for cryosurgery. |
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Cryoprobes Disposable probes used with the Cryocare
Surgical System. |
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FasTrac Percutaneous access device that allows one
step insertion of cryoprobes. |
Additional Cryosurgical Markets:
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Cryocare Surgical System A cryosurgical system with
eight cryoprobe capability specially configured for
interventional radiology and oncology. |
Raw Materials
We rely on third party suppliers to provide certain critical
components for all of our product lines. In certain cases, the
suppliers are our sole source of supply for these components.
Our policy is to enter into long-term supply agreements that
require suppliers to maintain adequate inventory levels and
which contain other terms and conditions protecting us against
unforeseen interruptions in their production. We maintain
adequate stock levels at our own locations to ensure an
uninterrupted source of supply. Wherever possible, we seek to
establish secondary sources of supply or other manufacturing
alternatives. Nevertheless, despite these efforts,
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it is possible that we may experience an interruption in supply
of one or more of our critical components resulting in
backorders to our customers. However, we believe that we could
locate alternative sources of supply upon such terms and within
such a timeframe as would not result in a material adverse
effect on our business.
Patents and Intellectual Property
As of the end of December 2005, we have rights to 39 issued
United States patents relating to cryosurgical ablative
technology. Included within these 39 issued United States
patents are 4 patents in which we have licensed-in rights. The
remainder of the patents are assigned to us. Most of these
patents relate to our cryoprobe technology for creating the
freeze zone and precisely controlling the shape of the freeze
zone produced by the cryoprobes. Additionally, our patents
relate to our computer guided system for assisting surgeons in
properly placing cryoprobes in a patient, a computer controlled
cryosurgery apparatus and method, a cryosurgical integrated
control and monitoring system and urethral warming technology.
We also have 14 pending Unites States patent applications
relative to cryosurgical ablative technology. Additionally, we
have 35 foreign patents and pending foreign patent applications
in this technology area. The earliest of our patents do not
expire until 2011. Most of the earliest patents in our core
technology area do not expire until about 2016.
Our policy is to secure and protect intellectual property rights
relating to our technology through patenting inventions and
licensing others when necessary. While we believe that the
protection of patents and licenses is important to our business,
we also rely on trade secrets, know-how and continuing
technological innovation to maintain our competitive position.
Given our technology and patent portfolio, we do not consider
the operation of our business to be materially dependent upon
any one patent, group of patents or single technological
innovation.
Our policy is to sell our products under trademarks and to
secure trademark protection in the United States and worldwide
where possible. We believe the protection of our trademarks is
important to our business.
No assurance can be given that our processes or products will
not infringe patents or other intellectual property rights of
others or that any license required would be made available
under any such patents or intellectual property rights, on terms
acceptable to us or at all. In the past, we have received
correspondence alleging infringement of intellectual property
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 could be required to
obtain licenses from the owners of any such intellectual
property rights to avoid infringement.
We seek to preserve the confidentiality of our technology by
entering into confidentiality agreements with our employees,
consultants, customers and key vendors and by other means. No
assurance can be given, however, that these measures will
prevent the unauthorized disclosure or use of such technology.
Research Strategy
Our research goal is to develop innovative cryoablation
technology that dramatically improves patient outcomes. Our
primary focus is on developing devices for the treatment of
prostate, kidney, lung and liver tumors and the pain associated
with bone metastases. To that end, we plan to develop
innovations that improve the speed and efficacy of our Cryocare
Surgical System, as well as to explore new applications for use
of our technology platform in the body.
We spent approximately $1.1 million, $1.9 million and
$2.3 million for the years ended 2003, 2004 and 2005
respectively, on research and development activities from
continuing operations.
7
Sales
We sell our products primarily to physicians, hospitals and
third party service providers and have both domestic and
international customers. None of our customers accounted for in
excess of 10 percent of our net revenues in 2004. The
following products and services account for 15 percent or
more of total revenues from continuing operations for each of
the years ended December 31:
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2003 | |
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2004 | |
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2005 | |
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| |
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| |
|
| |
Cryoablation and urological products:
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|
|
|
|
|
|
|
|
|
|
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|
Cryocare Surgical Systems
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* |
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|
* |
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|
* |
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|
Cryoprobes, disposables and procedures
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91 |
% |
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|
91 |
% |
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|
94 |
% |
|
Cardiac products (CryoCath)
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* |
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|
* |
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|
|
* |
|
|
|
* |
These products account for less than 15 percent of total
revenues. |
We currently sell our cryosurgical products domestically through
our direct sales force, which, as of December 31, 2005
consisted of 31 people, including 25 sales representatives and
sales managers and 6 cryosurgical field technicians. Our
strategy is to continue to introduce the clinical benefits of
cryosurgery to new physicians as well as educating physicians
already performing cryosurgery so that they are able to
increasingly incorporate cryosurgery into their primary
treatment plans. We also intend to create patient demand by
providing education regarding the benefits of cryosurgical
therapy versus alternative treatment options and by using
national advertising and other programs targeted directly at
prostate cancer patients.
Internationally, our cryosurgical products are sold primarily
through independent distributors. Our international sales from
continuing operations represented approximately
7.2 percent, 8.1 percent and 6.9 percent of our
consolidated revenue in 2003, 2004 and 2005, respectively.
We derive our revenues from continuing operations from the
following geographic regions for each of the years ended
December 31:
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2003 | |
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2004 | |
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2005 | |
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| |
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| |
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| |
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(In thousands) | |
United States
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|
$ |
18,184 |
|
|
$ |
22,234 |
|
|
$ |
26,322 |
|
International:
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|
|
|
|
|
|
|
|
|
|
|
|
China
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|
|
511 |
|
|
|
556 |
|
|
|
567 |
|
|
Canada
|
|
|
30 |
|
|
|
760 |
|
|
|
1,015 |
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Other
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|
879 |
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|
|
631 |
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|
|
370 |
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|
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|
Total international
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|
1,420 |
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|
|
1,947 |
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|
|
1,952 |
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|
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|
|
|
|
|
|
Total revenues
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|
$ |
19,604 |
|
|
$ |
24,181 |
|
|
$ |
28,274 |
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Reimbursement
We sell our Cryocare Surgical System and related disposable
temperature probes and cryoprobes to hospitals and third party
service companies that provide services to hospitals. A majority
of procedures involving the Cryocare Surgical System are
performed in hospitals on an inpatient basis. While patients
occasionally pay for cryosurgical procedures directly, most
patients depend upon third-party payors, including Medicare,
Medicaid, Tricare and other federal health care programs, as
well as private insurers to pay for their procedures.
Accordingly, our revenue is dependent upon third-party
reimbursement, particularly Medicare, since an estimated
70 percent of patients receiving cryosurgical treatments
using our proprietary technology are Medicare beneficiaries.
8
Medicare reimbursement for cryosurgical procedures using our
products as a primary treatment alternative for localized
prostate cancer began in July 1999. Effective July 2001,
Medicare coverage was approved for secondary cryosurgical
treatment of prostate cancer patients who have failed radiation
therapy.
When Medicare-reimbursed services are provided on an inpatient
basis, the hospital is reimbursed under the Medicare prospective
payment system, based on the applicable diagnosis related group.
A single payment covers all facility services.
Outpatient reimbursement for cryosurgical procedures for
Medicare beneficiaries is in accordance with the Hospital
Outpatient Prospective Payment System, or HOPPS. Under HOPPS,
the hospital is paid on a per procedure basis, based on the
ambulatory payment classification for the procedure. The payment
to the hospital includes the per procedure share of the cost for
any depreciable equipment, such as our Cryocare Surgical System
unit, and the provision of disposable devices, such as our
temperature probes and cryoprobes.
We are exploring percutaneous ablation of cancerous tissue in
bone, kidney, lung and liver. Clinical studies are underway and
as soon as studies are complete coverage decisions and unique
reimbursement codes will be sought from Medicare and private
payors. As of December 31, 2005, no such codes were in
place except for a tracking code established for
percutaneous renal cryoablation. This tracking code is a
significant step towards assignment of a Category I CPT code and
wider acceptance for payment.
Clearance to market a new device or technology by the FDA does
not guarantee payment by Medicare or other payors. Future
devices and technology that we develop would have to be approved
for coverage by Medicare after we obtain FDA approval or
clearance. The Medicare approval process is lengthy and there is
no assurance that Medicare approval would be granted. Each
private insurer makes its own determination whether to cover a
device or procedure and sets its own reimbursement rate.
Backlog
As of December 31, 2005, we had no backlog for our
cryosurgical products. Our policy is to carry enough inventory
to be able to ship most orders within a few days of receipt of
order. Historically, most of our orders have been for shipment
within 30 days of the placement of the order. Therefore, we
rely on orders placed during a given period for sales during
that period. Backlog information as of the end of a particular
period is not necessarily indicative of future levels of our
revenue.
Manufacturing
We manufacture our Cryocare Surgical System and related
disposables at our facilities in Irvine, California. Our
facility has been inspected by the California Department of
Health Services and has been issued a Device Manufacturing
License.
Our current manufacturing facility was subjected to Quality
System Regulation compliance inspections by the FDA most
recently in June 2004, and also in February and March 2003 and
September 2002. These audits have been closed by the FDA. We
have received ISO 9001, ISO 13485, and CE Marking
certifications, indicating compliance with European standards
for quality assurance and manufacturing process control.
Government Regulation
Governmental regulation in the United States and other countries
is a significant factor affecting the research and development,
manufacture and marketing of medical devices, including our
products. In the United States, the FDA has broad authority
under the Federal Food, Drug and Cosmetic Act, the FD&C Act,
to regulate the distribution, manufacture, marketing and sale of
medical devices. Foreign sales of medical devices are subject to
foreign governmental regulation and restrictions that vary from
country to country.
Medical devices intended for human use in the United States are
classified into one of three categories, depending upon the
degree of regulatory control to which they will be subject. Such
devices are classified by regulation into either Class I
general controls, Class II special standards or
Class III pre-market approval
9
depending upon the level of regulatory control required to
provide reasonable assurance of the safety and effectiveness of
the device.
Most Class I devices are exempt from premarket notification
or approval. Class II devices are subject to the premarket
notification requirements under Section 510(k) of the
FD&C Act. For a 510(k) to be cleared by the FDA, the
manufacturer must demonstrate to the FDA that a device is
substantially equivalent to another legally marketed device that
was either cleared through the 510(k) process or on the market
prior to 1976. It generally takes four to twelve months from the
date of submission to obtain 510(k) clearance although it may
take longer, in particular if clinical trials are required.
Class III devices generally include the most risky devices
as well as devices that are not substantially equivalent to
other legally marketed devices. To obtain approval to market a
Class III device, a manufacturer must obtain FDA approval
of a premarket approval application, or PMA. The PMA process
requires more data, takes longer and is more expensive than the
510(k) procedure.
Our Cryocare Surgical Systems have been cleared for marketing
through the 510(k) process.
We can provide no assurance that we will be able to obtain
clearances or approvals for clinical testing or for
manufacturing and sales of our existing products for all
applications in all targeted markets, or that we will be able to
obtain clearances or approvals needed to introduce new products
and technologies. After a device is placed on the market,
numerous regulatory requirements apply. These include:
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quality system regulation, which requires manufacturers to
follow design, testing, control, documentation and other quality
assurance procedures during the manufacturing process; |
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labeling regulations, which prohibit the promotion of products
for unapproved or off-label uses and impose other
restrictions on labeling; and |
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medical device reporting regulations, which require that
manufacturers report to the FDA if their device may have caused
or contributed to a death or serious injury or malfunctioned in
a way that would likely cause or contribute to a death or
serious injury if it were to recur. |
Failure to comply with applicable regulatory requirements can
result in enforcement action by the FDA, which may include any
of the following sanctions:
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fines, injunctions, and civil penalties; |
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recall or seizure of our products; |
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operating restrictions, partial suspension or total shutdown of
production; |
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refusing our request for 510(k) clearance or premarket approval
of new products; |
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withdrawing 510(k) clearance or premarket approvals that are
already granted; and |
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criminal prosecution. |
Medical device laws are also in effect in many of the countries
outside of the United States in which we do business. These laws
range from comprehensive device approval and quality system
requirements for some or all of our medical device products to
simple requests for product data or certifications. The number
and scope of these requirements are increasing. In June 1998,
the European Union Medical Device Directive became effective,
and all medical devices must meet the Medical Device Directive
standards and receive CE mark certification. CE mark
certification involves a comprehensive Quality System program,
and submission of data on a product to the Notified Body in
Europe.
We have obtained CE Mark for distribution of our Cryocare
Surgical System in Europe and approval for distribution in
Australia, Canada, New Zealand, China, Taiwan, and Mexico.
Health Care Regulatory Issues
The health care industry is highly regulated and the regulatory
environment in which we operate may change significantly in the
future. In general, regulation of health care-related companies
is increasing. We
10
anticipate that Congress and state legislatures will continue to
review and assess alternative health care delivery and payment
systems. We cannot predict what impact the adoption of any
federal or state health care reform measures may have on our
business.
We regularly monitor developments in statutes and regulations
relating to our business. We may be required to modify our
agreements, operations, marketing and expansion strategies from
time to time in response to changes in the statutory and
regulatory environment. We plan to structure all of our
agreements, operations, marketing and strategies in accordance
with applicable law, although we can provide no assurance that
our arrangements will not be challenged successfully or that
required changes may not have a material adverse effect on our
business, financial condition, results of operations and cash
flows.
We believe that the following discussion summarizes all of the
material health care regulatory requirements to which we
currently are subject. Complying with these regulatory
requirements may involve expense to us, delay in our operations,
and/or restructuring of our business relationships. Violations
could potentially result in the imposition upon us of civil
and/or criminal penalties.
The federal health care program anti-kickback law
prohibits the knowing and willful offer, payment, solicitation
or receipt of any form of remuneration in return for, or in
order to induce, (i) the referral of a person for services,
(ii) the furnishing or arranging for the furnishing of
items or services or (iii) the purchase, lease, or order or
arranging or recommending purchasing, leasing or ordering any
item or service, in each case, reimbursable under any federal
health care program. Because our products are reimbursable under
Medicare, Medicaid and other federal health care programs, the
anti-kickback law applies. Many states have similar
anti-referral laws, and in many cases these laws apply to all
patients, not just federal health care program beneficiaries.
Noncompliance with, or violation of, the federal anti-kickback
law can result in exclusion from federal health care programs
and civil and criminal penalties. Similar penalties are provided
for violation of state anti-kickback laws. Several federal
courts have held that the anti-kickback law is violated if just
one purpose of payment is to induce the referral of patients. To
the extent that we are deemed to be subject to these federal or
similar state laws, we believe that our activities and
contemplated activities comply in all material respects with
such statutes and regulations.
Regulations to the federal anti-kickback law specify payment
practices that will not be subject to prosecution under the
anti-kickback law. These are known as the
safe-harbors. Failure to comply fully with a
safe-harbor does not mean the practice is per se illegal, and
many common arrangements in the health care industry do not fit
a safe harbor, yet are not violations of the anti-kickback law.
Rather, if a practice does not fit within a safe
harbor, no guarantee can be given that the practice will
be exempt from prosecution; it will be viewed under the totality
of the facts and circumstances.
Many of our relationships with customers, such as volume and
other discounts, fit within a safe harbor. However, our service
agreements with physician-owned entities do not fit completely
within a safe harbor. For example, the safe harbor for equipment
leases and the safe harbor for personal services both require
that the aggregate amount of the rental or service payment be
fixed in advance for the term of the arrangement, which must be
at least one year. However, where the need for medical
procedures is not known in advance, it is sometimes more
appropriate to arrange for payment on a per procedure basis,
rather than determining a years total compensation in
advance. For the reasons described below, certain of our
arrangements with physician-owned entities provide for payment
on a per procedure basis.
In the case of cryosurgery, as well as other procedures that
involve new or expensive technology, hospitals often do not want
to invest in the required capital equipment (for example, the
Cryocare CS System, at a cost of approximately $150,000 to
$200,000 per unit). Rather, hospitals enter into
arrangements with specialty mobile service providers or
equipment manufacturers to obtain the use of the necessary
equipment and disposable products (such as cryoprobes), as well
as technician services, where applicable, on a per procedure
basis. In the case of cryosurgical equipment and disposables,
some physicians have formed or invested in mobile service
providers that provide cryosurgical equipment, disposables and
services directly to hospitals. In such cases, our relationship
to the physician-owned entities is only as a seller of our
products, where discounts
11
are provided in accordance with the discount safe harbor.
However, in some cases, we contract directly with hospitals to
provide the necessary equipment, disposables and technical
support. These contracts generally provide for the hospital to
pay for the equipment/disposables/support package on a per
procedure basis. Since we are primarily in the business of
selling our equipment and disposable products, not providing
services, when we contract to provide equipment to hospitals,
whenever possible, we subcontract with a mobile service provider
or other equipment owner to furnish the equipment as our
subcontractor. A significant number of these businesses are
owned entirely or in part by urologists who purchase the
equipment in order to make cryosurgery available in their
communities. Since the hospitals pay us on a per procedure
basis, we in turn pay our subcontractors on a per procedure
basis pursuant to service agreements. These service agreements
do not meet a safe harbor since, as noted above, the safe
harbors for equipment leases and service arrangements require
that the aggregate payment for the term of the arrangement must
be set in advance. Although the service agreements do not meet a
safe harbor, our service agreements with physician-owned
entities include the following elements intended to address
anti-kickback law concerns:
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Physician-owned subcontractors are not compensated or otherwise
treated differently than non-physician-owned entities; |
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The per procedure payments under the subcontracts are intended
to reflect fair market value for the products and services
provided by the subcontractors; |
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|
Subcontracts are in writing and include a number of
representations regarding health care regulatory compliance
issues, including requiring the subcontractor to represent that
distributions to physician owners of the subcontractor are not
based on referrals; and |
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|
Physicians must make significant investments in order to
purchase our equipment. The fact that the physicians have
assumed bona fide business risk is an important factor in
demonstrating that the arrangement is not simply a way for
physicians to profit from their referrals. |
The Stark law prohibits a physician from referring a Medicare
patient for designated health services, or DHS, to
an entity with which the physician has a direct or indirect
financial relationship, whether in the nature of an ownership
interest or a compensation arrangement, subject only to limited
exceptions. The Stark law also prohibits the recipient of a
prohibited referral from billing for the DHS provided pursuant
thereto. DHS include inpatient and outpatient hospital services,
durable medical equipment and prosthetic devices. The entity
that bills Medicare for the DHS is considered to be the provider
of the DHS for Stark law purposes. Therefore, we are not
providers of DHS. Rather, the hospitals where the procedures are
performed are the providers of DHS, because they bill Medicare
for the cryosurgery procedures, and inpatient and outpatient
hospital services are DHS.
Physicians who have an ownership or compensation relationship
with the entities (such as mobile vendors) that furnish our
equipment to hospitals, and the hospitals that obtain equipment
and services directly or indirectly from such entities, are
considered to have an indirect compensation
arrangement, and therefore that relationship must meet a
Stark law exception in order for the physicians to make DHS
referrals to the hospital. There is a Stark law exception for
indirect compensation arrangements that applies if:
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(1) Fair Market Value Compensation. The compensation
to the physician under the arrangement (or, if the first link in
the chain of arrangements between the parties is an ownership or
investment interest by the referring physician, the first entity
up the chain that has a direct compensation arrangement with
next link in the chain) represents fair market value, and is not
determined in a manner that takes into account the volume or
value of referrals or other business generated by the physician
for the DHS entity; |
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(2) Written Contract. The arrangement is set out in
writing, signed by the parties, and specifies the services
covered by the arrangement; and |
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(3) Anti-Kickback Law Compliance. The arrangement
does not violate the anti-kickback law. |
12
Here, as noted above in connection with discussion of the
anti-kickback law, our service agreements are in writing, the
per procedure payments are intended to reflect fair market value
and are not determined in a manner that takes into account
referrals by owner-physicians to the hospital, and we believe
that the arrangements do not violate the anti-kickback law.
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HIPAA and Other Privacy Laws |
As of April 14, 2003, the privacy regulations developed
under the Health Insurance Portability and Accountability Act of
1996, referred to as HIPAA, took effect. The privacy
regulations place limitations on a covered
entitys use and disclosure of identifiable patient
information, including research data. While Endocare is not a
covered entity under HIPAA, Endocares
relationships with covered entities, such as hospitals and
physicians, sometimes implicate HIPAA. Accordingly, Endocare has
adopted policies and procedures regarding confidentiality and
each employee who comes into contact with Protected Health
Information (PHI or patient data) is trained in the proper
handling of such information. Endocare has also established
procedures to determine when Endocare is required to sign a
business associate agreement with a covered entity
in connection with receipt of PHI and when such measures are not
required.
We believe that we have implemented appropriate measures to
ensure that our relationships with covered entities are
appropriate and consistent with HIPAA. However, there are many
uncertainties remaining about how HIPAA applies to the medical
device business, and no assurance can be made that HIPAA will
not be interpreted in a manner that will hamper our ability to
conduct medical research and receive medical information for
other purposes as well.
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Other United States Regulatory Requirements |
In addition to the regulatory framework for product approvals,
we are and may be subject to regulation under federal and state
laws, including requirements regarding occupational health and
safety, laboratory practices and the use, handling, and
disposing of toxic or hazardous substances. We may also be
subject to other present and future local, state, federal and
foreign regulations.
Seasonality
We believe that holidays, major medical conventions and
vacations taken by physicians, patients and patient families may
have a seasonal impact on our sales of cryosurgical products
since cryosurgical procedures can be scheduled in advance. We
are continuing to monitor and assess the impact seasonality may
have on demand for our products.
Competition
The medical device industry is subject to intense competition.
Significant competitors in the area of prostate cancer therapies
include ONCURA, CR Bard, Inc., Mentor Corporation, Theragenics
Corporation and North American Scientific, Inc. We believe that
currently only ONCURA provides cryoablation products that
compete with our cryoablation products. However, we believe that
our cryoablation products provide superior technology and
greater functionality, at a price that is competitive. In
addition, other companies are developing urological products
that could compete with our Cryocare Surgical System. Many of
these competitors have significantly greater financial and human
resources than we do.
We believe the principal competitive factors in the cryoablation
product market include:
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the safety and efficacy of treatment alternatives; |
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acceptance of a procedure by physicians and patients; |
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technology leadership and superiority; |
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price; |
13
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availability of government or private insurance
reimbursement; and |
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speed to market. |
Employees
As of December 31, 2005, we had a total of
152 employees. Of these employees, 9 are engaged directly
in research and development activities, 8 in regulatory
affairs/quality assurance, 22 in manufacturing, 77 in sales,
marketing, clinical support and customer service and 36 in
general and administrative positions. Of this total, we had a
total of 35 employees at Timm Medical. As a result of our
sale of Timm Medical on February 10, 2006, these employees
are no longer employed by us. We expect to increase the number
of people employed in sales and marketing to increase revenue
and grow market share, measured in terms of cryoablation
procedures. We have never experienced a work stoppage, none of
our employees are represented by a labor organization, and we
consider our employee relations to be good.
Although we conduct most of our research and development using
our own employees, we occasionally have funded and plan to
continue to fund research using consultants. Consultants provide
services under written agreements and typically are paid based
on the amount of time spent on our matters. Under their
consulting agreements, such consultants typically are required
to disclose and assign to us any ideas, discoveries and
inventions created or developed by them in the course of
providing consulting services.
Available Information
Our website address is www.endocare.com. All filings we make
with the SEC, including our annual report on
Form 10-K, our
quarterly reports on
Form 10-Q, and our
current reports on
Form 8-K, and any
amendments thereto, are available at no charge through links
displayed on our website as soon as reasonably practicable after
they are filed or furnished to the SEC. The reference to our
website address does not constitute incorporation by reference
of the information contained on the website, and the information
contained on the website is not part of this document.
The risks and uncertainties described below are not the only
ones we face. 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 the following 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 Surgical 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. In addition, we are generally obliged, to the extent
permitted by law, to indemnify 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 external investigations.
Our management members continue to spend considerable time and
effort dealing with the SEC and DOJ investigations involving our
previous internal controls, accounting policies and procedures,
disclosure
14
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 December 31, 2005, our accumulated deficit
was approximately $165.7 million and cash equivalents of
$8.1 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:
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incur costs related to legal proceedings, including ongoing
government investigations; |
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attempt to get our stock relisted on a national exchange; |
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comply with changes in generally accepted accounting principles
and include employee based stock option charges in our
consolidated statement of operations in 2006; |
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comply with the increasing complexities and costs of being a
public company, such as Sarbanes-Oxley compliance; |
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expand our sales and marketing activities as we attempt to gain
market share for our Cryocare Surgical System; and |
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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, including expenses related to our
efforts to achieve compliance with the internal control
reporting requirements of Section 404 of the Sarbanes-Oxley
Act. We face large cash expenditures in the future related to
past due state and local tax obligations. 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 II, Item 7
Managements Discussion and Analysis of Financial Condition
and Results of Operations Liquidity and Capital
Resources.
We may be required to make state and local tax payments that
exceed our settlement estimates.
As of December 31, 2004 and 2005 we estimated that we owed
$2.9 million as of each balance sheet date in state and
local taxes, primarily sales and use taxes in various
jurisdictions in the United States. We are in the process of
negotiating resolutions of the past due state and local tax
obligations with the applicable tax authorities. While we hope
that these obligations can be settled for less than the amounts
accrued, we cannot predict whether we will obtain favorable
settlement terms from the various tax authorities, or that,
after settling, we will satisfy the conditions necessary to
avoid violating the settlements. Our failure to obtain favorable
settlement terms or to satisfy the settlement conditions may
result in a material adverse effect on our business, financial
condition, results of operations and cash flows.
15
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, Michael R. Rodriguez, our Senior
Vice President, Finance and Chief Financial Officer, and
Clint B. Davis, our Senior Vice President, Legal Affairs
and General Counsel. 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 30,147,894 shares of common stock
outstanding as of February 28, 2006, which included
5,635,378 shares of our common stock that we issued on
March 11, 2005 in connection with the 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. The
registration statement became effective on September 28,
2005. 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
(NASDAQ) on January 16, 2003 because of our
failure to keep current in filing our periodic reports with the
SEC. Trading is now conducted in the
over-the-counter market
on the so-called bulletin board. Consequently,
selling our common stock is more difficult because smaller
quantities of shares can be bought and sold, transactions can be
delayed and security analyst and news media coverage of us may
be reduced. These factors 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 the American Stock Exchange (AMEX)
and NASDAQ regarding the relisting of our common stock. We hope
that our common stock will be relisted with either AMEX, the
NASDAQ Capital Market or the NASDAQ Global Market by the end of
2006, 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.
16
In order to qualify our stock for 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. AMEX requires a minimum bid price of $3.00,
the NASDAQ Capital Market requires a minimum bid price of $4.00
and the NASDAQ Global Market requires a minimum bid price of
$5.00. As of February 28, 2006, the closing price for our
common stock as reported on the bulletin board 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 by a vote of more than 70 percent authorized our board
of directors to effectuate a reserve stock split. 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. We expect to ask our
stockholders to reauthorize the reverse stock split for an
additional year at our 2006 annual stockholders meeting.
In many instances historically the markets have reacted
negatively to the effectuation of a reverse stock split. The
trading price of our stock may 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.
Our success is reliant on the acceptance by doctors and
patients of the Cryocare Surgical System as a preferred
treatment for tumor ablation.
Cryosurgery has existed for many years, but has not been widely
accepted primarily due to concerns regarding safety and efficacy
and widespread use of alternative therapies. Because the
technology previously lacked precise monitoring capabilities,
cryosurgical procedures performed in the 1970s resulted in high
cancer recurrence and negative side effects, such as rectal
fistulae and incontinence, and gave cryosurgical treatment
negative publicity. To overcome these negative side effects, we
have developed ultrasound guidance and temperature sensing to
enable more precise monitoring in our Cryocare Surgical System.
Nevertheless, we will need to overcome the earlier negative
publicity associated with cryosurgery in order to obtain market
acceptance for our products. In addition, use of our Cryocare
Surgical System requires significant physician education and
training. As a result, we may have difficulty obtaining
recommendations and endorsements of physicians and patients for
our Cryocare Surgical System. We may also have difficulty
raising the brand awareness necessary to generate interest in
our Cryocare Surgical System. Any adverse side effects,
including impotence or incontinence, recurrence of cancer or
future reported adverse events or other unfavorable publicity
involving patient outcomes from the use of cryosurgery, whether
from our products or the products of our competitors, could
adversely affect acceptance of cryosurgery. In addition,
emerging new technologies and procedures to treat cancer,
prostate enlargement and other prostate disorders may negatively
affect the market acceptance of cryosurgery. If our Cryocare
Surgical System does not achieve broad market acceptance, we
will likely remain unprofitable.
We are faced with intense competition and rapid technological
and industry change, which may make it more difficult for us to
achieve significant market penetration.
The medical device industry generally, and the cancer treatment
market in particular, are characterized by rapid technological
change, changing customer needs, and frequent new product
introductions. If our competitors existing products or new
products are more effective than or considered superior to our
products,
17
the commercial opportunity for our products will be reduced or
eliminated. We face intense competition from companies in the
cryosurgical marketplace as well as companies offering other
treatment options, including radical prostatectomy, radiation
therapy and hormone therapy. If we are successful in penetrating
the market for treatment of prostate cancer with our
cryosurgical treatment, other medical device companies may be
attracted to the marketplace. Many of our potential competitors
are significantly larger than we are and have greater financial,
technical, research, marketing, sales, distribution and other
resources than we do. We believe there will be intense price
competition for products developed in our markets. Our
competitors may develop or market technologies and products that
are more effective or commercially attractive than any that we
are developing or marketing. Our competitors may obtain
regulatory approval, and introduce and commercialize products
before we do. These developments could have a material adverse
effect on our business, financial condition, results of
operations and cash flows. Even if we are able to compete
successfully, we may not be able to do so in a profitable manner.
If we are unable to continue to develop and enhance our
Cryocare Surgical System, our business will suffer.
Our growth depends in part on continued ability to successfully
develop enhancements to our Cryocare Surgical System. We may
experience difficulties that could delay or prevent the
successful development and commercialization of these products.
Our products in development may not prove safe and effective in
clinical trials. Clinical trials may identify significant
technical or other obstacles that must be overcome before
obtaining necessary regulatory or reimbursement approvals. In
addition, our competitors may succeed in developing commercially
viable products that render our products obsolete or less
attractive. Failure to successfully develop and commercialize
new products and enhancements would likely have a significant
negative effect on our financial prospects.
There is uncertainty relating to third-party reimbursement,
which is critical to market acceptance of our products.
Hospitals and other health care providers in the United States
generally rely on third-party payors, principally federal
Medicare, state Medicaid and private health insurance plans, to
reimburse all or part of the cost of medical procedures
involving our products. While private health insurers in some
areas of the United States provide reimbursement for procedures
in which our products are used, we can provide no assurance that
private insurance reimbursement will be adopted nationally or by
additional insurers. Furthermore, those private insurance
companies currently paying for procedures in which our products
are used may terminate such coverage. If reimbursement levels
from Medicare, Medicaid, other governmental health care programs
or private insurers are not sufficient, physicians may choose
not to recommend, and patients may not choose, procedures using
our products.
International market acceptance of our products may depend, in
part, upon the availability of reimbursement within prevailing
health care payment systems. Reimbursement and health care
payment systems in international markets vary significantly by
country, and include both government sponsored health care and
private insurance. We may not obtain international reimbursement
approvals in a timely manner, if at all. Our failure to receive
international reimbursement approvals may negatively impact
market acceptance of our products in the international markets
in which those approvals are sought.
From time to time significant attention has been focused on
reforming the health care system in the United States and other
countries. Any changes in Medicare, Medicaid or third-party
medical expense reimbursement, which may arise from health care
reform, may have a material adverse effect on reimbursement for
our products or procedures in which our products are used and
may reduce the price we are able to charge for our products. In
addition, changes to the health care system may also affect the
commercial acceptance of products we are currently developing
and products we may develop in the future. Potential approaches
that have been considered include controls on health care
spending and price controls. Several proposals have been made in
the United States Congress and various state legislatures
recently that, if adopted, would potentially reduce health care
spending, which may result in a material adverse effect on our
business, financial condition, results of operations and cash
flows.
18
We believe that our current structure and business and our
contemplated future operations comply and will comply with the
federal anti-kickback law. However, certain of our business
practices do not fit or will not fit within a safe
harbor and there is no assurance that if viewed under the
totality of the facts and circumstances, our structure and
business would not be challenged, perhaps even successfully, as
a violation of the anti-kickback law. Mere challenge, even if we
ultimately prevail, could have a material adverse effect on our
business.
We could be difficult to acquire due to anti-takeover
provisions in our charter, our stockholders rights plan and
Delaware law.
Provisions of our certificate of incorporation and bylaws may
have the effect of making it more difficult for a third party to
acquire, or of discouraging a third party from attempting to
acquire control of our company. In addition, our board of
directors has adopted a stockholder rights plan in which
preferred stock purchase rights were distributed as a dividend.
These provisions may make it more difficult for stockholders to
take corporate actions and may have the effect of delaying or
preventing a change in control. These provisions also could
deter or prevent transactions that stockholders deem to be in
their interests. In addition, we are subject to the
anti-takeover provisions of Section 203 of the Delaware
General Corporation Law. Subject to specified exceptions, this
section provides that a corporation may not engage in any
business combination with any interested stockholder during the
three-year period following the time that such stockholder
becomes an interested stockholder. This provision could have the
effect of delaying or preventing a change of control of our
company. The foregoing factors could reduce the price that
investors or an acquiror might be willing to pay in the future
for shares of our common stock.
If we fail to protect our intellectual property rights, our
competitors may take advantage of our ideas and compete directly
against us.
Our success will depend to a significant degree on our ability
to secure and protect intellectual property rights and to
enforce patent and trademark protections relating to our
technology. From time to time, litigation may be advisable to
protect our intellectual property position, however, these legal
means afford only limited protection and may not adequately
protect our rights or permit us to gain or keep any competitive
advantage. Any litigation in this regard could be costly, and it
is possible that we will not have sufficient resources to fully
pursue litigation or to protect our other intellectual property
rights. It could result in the rejection or invalidation of our
existing and future patents. Any adverse outcome in litigation
relating to the validity of our patents, or any failure to
pursue litigation or otherwise to protect our patent position,
could have a material adverse effect on our business, financial
condition, results of operations and cash flows. Also, even if
we prevail in litigation, the litigation would be costly in
terms of management distraction as well as in terms of money. In
addition, confidentiality agreements with our employees,
consultants, customers, and key vendors may not prevent the
unauthorized disclosure or use of our technology. It is possible
that these agreements could be breached or that they might not
be enforceable in every instance, and that we might not have
adequate remedies for any such breach. Enforcement of these
agreements may be costly and time consuming. Furthermore, the
laws of foreign countries may not protect our intellectual
property rights to the same extent as the laws of the United
States.
Because the medical device industry is litigious, we may be
sued for allegedly violating the intellectual property rights of
others.
The medical technology industry has in the past been
characterized by a substantial amount of litigation and related
administrative proceedings regarding patents and intellectual
property rights. In addition, major medical device companies
have used litigation against emerging growth companies as a
means of gaining or preserving a competitive advantage.
Should third parties file patent applications or be issued
patents claiming technology also claimed by us in pending
applications, we may be required to participate in interference
proceedings in the United States Patent and Trademark Office to
determine the relative priorities of our inventions and the
third parties inventions. We could also be required to
participate in interference proceedings involving our issued
patents
19
and pending applications of another entity. An adverse outcome
in an interference proceeding could require us to cease using
the technology or to license rights from prevailing third
parties.
Third parties may claim we are using their patented inventions
and may go to court to stop us from engaging in our normal
operations and activities. These lawsuits are expensive to
defend and conduct and would also consume and divert the time
and attention of our management. A court may decide that we are
infringing a third partys patents and may order us to
cease the infringing activity. A court could also order us to
pay damages for the infringement. These damages could be
substantial and could have a material adverse effect on our
business, financial condition, results of operations and cash
flows.
If we are unable to obtain any necessary license following an
adverse determination in litigation or in interference or other
administrative proceedings, we would have to redesign our
products to avoid infringing a third partys patent and
could temporarily or permanently have to discontinue
manufacturing and selling some of our products. If this were to
occur, it would negatively impact future sales and, in turn, our
business, financial condition, results of operations and cash
flows.
If we fail to obtain or maintain necessary regulatory
clearances or approvals for products, or if approvals are
delayed or withdrawn, we will be unable to commercially
distribute and market our products or any product
modifications.
Government regulation has a significant impact on our business.
Government regulation in the United States and other countries
is a significant factor affecting the research and development,
manufacture and marketing of our products. In the United States,
the FDA has broad authority under the federal Food, Drug and
Cosmetic Act to regulate the distribution, manufacture and sale
of medical devices. Foreign sales of drugs and medical devices
are subject to foreign governmental regulation and restrictions,
which vary from country to country. The process of obtaining FDA
and other required regulatory clearances and approvals is
lengthy and expensive. We may not be able to obtain or maintain
necessary approvals for clinical testing or for the
manufacturing or marketing of our products. Failure to comply
with applicable regulatory approvals can, among other things,
result in fines, suspension or withdrawal of regulatory
approvals, product recalls, operating restrictions, and criminal
prosecution. In addition, governmental regulations may be
established which could prevent, delay, modify or rescind
regulatory approval of our products. Any of these actions by the
FDA, or change in FDA regulations, could have a material adverse
effect on our business, financial condition, results of
operations and cash flows.
Regulatory approvals, if granted, may include significant
limitations on the indicated uses for which our products may be
marketed. In addition, to obtain such approvals, the FDA and
foreign regulatory authorities may impose numerous other
requirements on us. FDA enforcement policy prohibits the
marketing of approved medical devices for unapproved uses. In
addition, product approvals can be withdrawn for failure to
comply with regulatory standards or unforeseen problems
following initial marketing. We may not be able to obtain or
maintain regulatory approvals for our products on a timely
basis, or at all, and delays in receipt of or failure to receive
such approvals, the loss of previously obtained approvals, or
failure to comply with existing or future regulatory
requirements could have a material adverse effect on our
business, financial condition, results of operations and cash
flows.
Our products may be subject to product recalls even after
receiving FDA clearance or approval, which would harm our
reputation and our business.
The FDA and similar governmental authorities in other countries
have the authority to request and, in some cases, require the
recall of our products in the event of material deficiencies or
defects in design or manufacture. A governmental mandated or
voluntary recall by us could occur as a result of component
failures, manufacturing errors or design defects. Any recall of
product would divert managerial and financial resources and harm
our reputation with customers and our business.
20
We could be negatively impacted by future interpretation or
implementation of the federal Stark law and other federal and
state anti-referral laws.
The federal Stark law prohibits a physician from referring
medical patients for certain services to an entity with which
the physician has a financial relationship. A financial
relationship includes both investment interests in an entity and
compensation arrangements with an entity. Many states have
similar and often broader laws prohibiting referrals by any
licensed health care provider to entities with which they have a
financial relationship. These state laws generally apply to
services reimbursed by both governmental and private payors.
Violation of these federal and state laws may result in
prohibition of payment for services rendered, loss of licenses,
fines, criminal penalties and exclusion from governmental and
private payor programs, among other things. We have financial
relationships with physicians and physician-owned entities,
which in turn have financial relationships with hospitals and
other providers of designated health services. Although we
believe that our financial relationships with physicians and
physician-owned entities, as well as the relationships between
physician-owned entities that purchase or lease our products and
hospitals, are not in violation of applicable laws and
regulations, governmental authorities might take a contrary
position. If our financial relationships with physicians or
physician-owned entities or the relationships between those
entities and hospitals were found to be illegal, we and/or the
affected physicians and hospitals could be subject to civil and
criminal penalties, including fines, exclusion from
participation in government and private payor programs and
requirements to refund amounts previously received from
government and private payors. In addition, expansion of our
operations to new jurisdictions, or new interpretations of laws
in our existing jurisdictions, could require structural and
organizational modifications of our relationships with
physicians, physician-owned entities and others to comply with
that jurisdictions laws. For a further description of the
federal Stark law see above under Item 1
Health Care Regulatory Issues.
We believe that the arrangements we have established with
physician-owned entities and hospitals comply with applicable
Stark law exceptions. However, if any of the relationships
between physicians and hospitals involving our services do not
meet a Stark law exception, neither the hospital nor we would be
able to bill for any procedure resulting from a referral that
violated the Stark law. Although, in most cases we are not the
direct provider and do not bill Medicare for the designated
health services, any Stark law problem with our business
arrangements with physicians and hospitals would adversely
affect us as well as the referring physician and the hospital
receiving the referral.
Many states also have patient referral laws, some of which are
more restrictive than the Stark law and regulate referrals by
all licensed health care practitioners for any health care
service to an entity with which the licensee has a financial
relationship unless an exception applies. Such laws in
particular states may prohibit us from entering into
relationships with physicians and physician-owned entities,
which may limit business development.
We believe that our business practices comply with the Stark law
and applicable state referral laws. No assurance can be made,
however, that these practices would not be successfully
challenged and penalties, such as civil money penalties and
exclusion from Medicare and Medicaid, and/or state penalties,
imposed. And again, mere challenge, even if we ultimately
prevail, could have a material adverse effect on us.
If we become subject to product liability claims, we may be
required to pay damages that exceed our insurance coverage.
Our business exposes us to potential product liability claims
that are inherent in the testing, production, marketing and sale
of medical devices. While we believe that we are reasonably
insured against these risks, we may not be able to maintain
insurance in amounts or scope sufficient to provide us with
adequate coverage. A claim in excess of our insurance coverage
would have to be paid out of cash reserves, which could have a
material adverse effect on our business, financial condition,
results of operations and cash flows. In addition, any product
liability claim likely would harm our reputation in the industry
and our business.
21
Fluctuations in our future operating results may negatively
impact the market price of our common stock.
Our operating results have fluctuated in the past and can be
expected to fluctuate from time to time in the future. Some of
the factors that may cause these fluctuations include the
following:
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market acceptance of our existing products, as well as products
in development; |
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timing of payments received and the recognition of such payments
as revenue under collaborative arrangements and strategic
alliances; |
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ability to manufacture products efficiently; |
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timing of our research and development expenditures; |
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timing of customer orders; |
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changes in reimbursement rates for our products and procedures
by Medicare and other third-party payors; |
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timing of regulatory approvals for new products; |
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outcomes of clinical studies by us or our competitors; |
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competition from other treatment modalities; |
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physician and patient acceptance of cryosurgery; and |
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ability to obtain reimbursement for procedures in lung and liver
cancer, and pain related to bone metastases. |
If our operating results are below the expectations of
securities analysts or investors, the market price of our common
stock may fall abruptly and significantly.
Our stock price may be volatile and your investment could
decline in value.
Our stock price has fluctuated significantly in the past and is
likely to continue to fluctuate significantly, making it
difficult to resell shares when investors want to at prices they
find attractive. The market prices for securities of emerging
companies have historically been highly volatile. Future events
concerning us or our competitors could cause such volatility
including:
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actual or anticipated variations in our operating results and
cash flows; |
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developments regarding government and third-party reimbursement; |
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changes in government regulation of our products and business
practices; |
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developments concerning government investigations of us; |
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developments concerning proprietary rights; |
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developments concerning litigation or public concern as to the
safety of our products or our competitors products; |
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technological innovations or introduction of new products by us
or our competitors; |
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investor and analyst perception of us and our industry; |
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introduction of new competing technologies; |
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general economic and market conditions; and |
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physician and patient acceptance of cryosurgery. |
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In addition, the stock market is subject to price and volume
fluctuations that affect the market prices for companies in
general, and small-capitalization, high technology companies in
particular, which are often unrelated to the operating
performance of these companies.
Our intangible assets and goodwill could become impaired.
Intangible assets acquired in a purchase, such as intellectual
property or developed technology, are generally amortized over
various periods depending on their anticipated economic benefits
or useful lives. Long-lived assets, including amortizable
intangibles, are reviewed for impairment whenever events or
changes in circumstances indicate that the carrying amount of an
asset may not be recoverable. Recoverability of assets to be
held and used is measured by a comparison of the carrying amount
of an asset to future net cash flows expected to be generated by
the asset. Following a review, if such assets are considered to
be impaired, the impairment to be recognized is measured by the
amount by which the carrying value of the assets exceeds the
fair value of the assets. Significant estimates, including
assumptions regarding future events and circumstances that
cannot be easily predicted are required to perform an analysis
of the value of goodwill and intangible assets. These estimates
and assumptions may differ materially from actual outcomes and
occurrences.
Our facilities and systems are vulnerable to natural
disasters or other catastrophic events.
Our headquarters, cryosurgical products manufacturing
facilities, research facilities and much of our infrastructure,
including computer servers, are located in California, an area
that is susceptible to earthquakes and other natural disasters.
A natural disaster or other catastrophic event, such as an
earthquake, fire, flood, severe storm, break-in, terrorist
attack or other comparable problems could cause interruptions or
delays in our business and loss of data or render us unable to
accept and fulfill customer orders in a timely manner, or at
all. We have no formal disaster recovery plan and our business
interruption insurance may not adequately compensate us for
losses that may occur. In the event that an earthquake, natural
disaster or other catastrophic event were to destroy any part of
our facilities or interrupt our operations for any extended
period of time, or if harsh weather conditions prevent us from
delivering products in a timely manner, our business, financial
condition and operating results would be seriously harmed.
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Item 1B. |
Unresolved Staff Comments |
Not applicable.
In April 2002, we moved our executive offices, as well as our
principal manufacturing and research facilities, to a
28,000 square foot facility in Irvine, California. The
lease for this facility expires in 2007, with an option to
extend the lease for an additional five years. We believe that
our property and equipment are generally well maintained, in
good operating condition and are sufficient to meet our current
needs.
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Item 3. |
Legal Proceedings |
We are a party to lawsuits in the normal course of our business.
Litigation and governmental investigation can be expensive and
disruptive to normal business operations. Moreover, the results
of complex legal proceedings are difficult to predict.
Significant judgments or settlements in connection with the
legal proceedings described below may have a material adverse
effect on our business, financial condition, results of
operations and cash flows. See Item 7
Managements Discussion and Analysis of Financial Condition
and Results of Operations. Other than as described below,
we are not a party to any material legal proceedings.
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 of the SEC
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 during the year
ended December 31, 2004);
23
(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.
We previously reported that we were involved in arbitration with
our first excess directors and officers liability
insurance carrier. The carrier was seeking rescission of its
policy and return of up to $5 million that the carrier
paid, subject to reservation of rights, in connection with our
settlement of a securities class-action lawsuit in November
2004. On December 1, 2005, we entered into a settlement
agreement with the carrier pursuant to which paid the carrier
$1 million in full settlement of any claims. Under the
settlement agreement, we also granted a mutual release to the
carrier.
|
|
Item 4. |
Submission of Matters to a Vote of Security Holders |
Not applicable.
24
PART II
|
|
Item 5. |
Market for Registrants Common Equity, Related
Stockholder Matters and Issuer Purchases of Equity
Securities |
Market Information
On January 16, 2003, our common stock was delisted from the
NASDAQ National Market and began to trade on the Pink Sheets. On
October 21, 2005, our stock began to trade on the
Over-the-Counter
Bulletin Board, or OTCBB. There currently is no
established public trading market for our common stock. The
symbol under which we trade on the OTCBB is ENDO.
The following table sets forth for the fiscal quarters
indicated, the high and low bid prices for our common stock as
reflected on the Pink Sheets or OTCBB, as applicable. Such
prices represent inter-dealer prices without retail mark up,
mark down or commission and may not necessarily represent actual
transactions.
|
|
|
|
|
|
|
|
|
|
|
|
High | |
|
Low | |
|
|
| |
|
| |
Year Ended December 31, 2005:
|
|
|
|
|
|
|
|
|
|
First Quarter
|
|
$ |
3.70 |
|
|
$ |
2.25 |
|
|
Second Quarter
|
|
|
4.40 |
|
|
|
2.98 |
|
|
Third Quarter
|
|
|
5.15 |
|
|
|
2.89 |
|
|
Fourth Quarter
|
|
|
3.29 |
|
|
|
2.35 |
|
Year Ended December 31, 2004:
|
|
|
|
|
|
|
|
|
|
First Quarter
|
|
$ |
4.40 |
|
|
$ |
2.95 |
|
|
Second Quarter
|
|
|
4.00 |
|
|
|
2.49 |
|
|
Third Quarter
|
|
|
3.24 |
|
|
|
2.10 |
|
|
Fourth Quarter
|
|
|
2.95 |
|
|
|
2.25 |
|
Holders
As of February 28, 2006, there were 269 holders of record
of our common stock. This number was derived from our
stockholder records and does not include beneficial owners of
our common stock whose shares are held in the names of various
dealers, clearing agencies, banks, brokers, and other
fiduciaries.
Dividends
We have never paid any cash dividends on our capital stock. We
anticipate that we will retain any future earnings to support
operations and to finance the growth and development of our
business. Therefore, we do not expect to pay cash dividends in
the foreseeable future. Any determination to pay dividends in
the future will be at the discretion of our board of directors
and will depend on existing conditions, including our financial
condition, contractual restrictions, capital requirements and
business prospects.
Recent Sales of Unregistered Securities
None, except as previously reported in a Quarterly Report on
Form 10-Q or
Current Report on
Form 8-K.
25
Issuer Purchases of Equity Securities
Not applicable.
|
|
Item 6. |
Selected Consolidated Financial Data |
The selected financial data set forth below should be read in
conjunction with Managements Discussion and Analysis
of Financial Condition and Results of Operations and our
consolidated financial statements and related notes included
elsewhere in this Annual Report on
Form 10-K. The
selected financial data as of and for the years ended
December 31, 2001, 2003 and 2004 were previously restated.
Detailed information regarding these restatements is disclosed
in Notes 3 and 16 to our consolidated financial statements
filed in our annual report on
Form 10-K for the
year ended December 31, 2002 and Note 2 to our
consolidated financial statements filed in our annual report on
Form 10-K (as
amended) for the year ended December 31, 2004. Our
historical results are not necessarily indicative of operating
results to be expected in the future.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2001 | |
|
2002 | |
|
2003 | |
|
2004 | |
|
2005 | |
|
|
| |
|
| |
|
| |
|
| |
|
| |
Revenues from continuing operations
|
|
$ |
13,037 |
|
|
$ |
17,901 |
|
|
$ |
19,604 |
|
|
$ |
24,181 |
|
|
$ |
28,274 |
|
Loss from continuing operations
|
|
$ |
(11,452 |
) |
|
$ |
(26,492 |
) |
|
$ |
(24,963 |
) |
|
$ |
(31,901 |
) |
|
$ |
(14,838 |
) |
Net loss per share of common stock basic and
diluted (continuing operations)
|
|
$ |
(0.68 |
) |
|
$ |
(1.11 |
) |
|
$ |
(1.03 |
) |
|
$ |
(1.31 |
) |
|
$ |
(0.51 |
) |
Weighted-average shares of common stock outstanding
|
|
|
16,741 |
|
|
|
23,822 |
|
|
|
24,162 |
|
|
|
24,263 |
|
|
|
28,978 |
|
Balance Sheet Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total assets
|
|
$ |
95,094 |
|
|
$ |
92,628 |
|
|
$ |
71,997 |
|
|
$ |
34,374 |
|
|
$ |
32,237 |
|
Common stock warrants
|
|
$ |
|
|
|
$ |
|
|
|
$ |
|
|
|
$ |
|
|
|
$ |
5,023 |
|
|
|
Item 7. |
Managements Discussion and Analysis of Financial
Condition and Results of Operations |
The following discussion should be read in conjunction with
Item 1 Business,
Item 1A Risk Factors,
Item 6 Selected Consolidated Financial
Data and Item 8 Financial
Statements and Supplementary Data, as well as our
consolidated financial statements and related notes contained
elsewhere in this Annual Report on
Form 10-K. 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 Annual Report on
Form 10-K,
including above under Risks Factors in Item 1A
of this Annual Report on
Form 10-K. In
addition, there are factors not described in this 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 Annual Report on
Form 10-K are
based on information available to us as of the date hereof, and
we assume no obligation to update any such forward-looking
statements.
Overview
We are an innovative medical device company focused on the
development of minimally invasive technologies for tissue and
tumor ablation through cryoablation, which is the use of ice to
destroy tissue, such as tumors, for therapeutic purposes. We
develop and manufacture devices for the treatment of prostate
and renal cancer and we believe that our proprietary
technologies have broad applications across a number of markets,
including the ablation of tumors in the lung and liver and pain
resulting from bone metastases.
Today, our FDA-cleared Cryocare Surgical System occupies a
growing position in the urological market for treatment of
prostate and renal cancers. Because of our initial concentration
on prostate and renal cancers, the majority of our sales and
marketing resources are directed toward the promotion of our
technology to urologists. In addition to selling our
cryosurgical disposable products to hospitals and mobile service
companies, we contract directly with hospitals and health care
payors for the use of our Cryocare Surgical
26
System and disposable products on a fee-for-service basis. Since
2003, we maintain a dedicated sales team focused on selling
percutaneous cryoablation procedures related to liver and lung
cancer and pain resulting from bone metastases to interventional
radiology physicians throughout the United States. We intend to
continue to identify and develop new markets for our
cryosurgical products and technologies, particularly in the area
of tumor ablation.
We previously owned Timm Medical Technologies, Inc. (Timm
Medical), a company focused on erectile dysfunction
products. We sold Timm Medical to UK-based Plethora Solutions
Holdings plc on February 10, 2006.
Strategy and Key Metrics
Our strategy is to achieve a dominant 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 cryosurgical technology.
Our primary objective is to grow market share, measured in terms
of the number of procedures performed with our Cryocare Surgical
System. 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 2005 procedures increased 35.9 percent to
6,407 from 4,713 in 2004. In 2006, 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
supplies used in procedures performed with the Cryocare Surgical
System, as shown below under Results of Operations.
In 2003 we redirected our strategy for our cryosurgical business
away from emphasizing sales of Cryocare Surgical Systems and
instead towards seeking to increase recurring sales of our
disposable products.
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 10-year data
published in 2005, increased awareness among patients of
cryoablation and its preferred outcomes as compared to other
modalities, the efforts of our dedicated cryoablation sales
force and our continued expenditure of funds on patient
education and advocacy.
27
Results of Operations
Revenues and cost of revenues from continuing operations related
to the following products and services for the three-year period
ended December 31, 2005 are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31, | |
|
|
| |
|
|
2003 | |
|
2004 | |
|
2005 | |
|
|
| |
|
| |
|
| |
|
|
(In thousands) | |
Revenues:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Product sales:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cryoablation disposable products
|
|
$ |
3,552 |
|
|
$ |
4,584 |
|
|
$ |
6,790 |
|
|
|
Cryocare surgical systems
|
|
|
1,283 |
|
|
|
1,403 |
|
|
|
743 |
|
|
|
Cardiac products (CryoCath)
|
|
|
331 |
|
|
|
|
|
|
|
|
|
|
|
Other (Urohealth)
|
|
|
60 |
|
|
|
49 |
|
|
|
72 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
5,226 |
|
|
|
6,036 |
|
|
|
7,605 |
|
|
Cryoablation procedure fees
|
|
|
14,378 |
|
|
|
17,516 |
|
|
|
19,780 |
|
|
Cardiac royalties (CryoCath)
|
|
|
|
|
|
|
629 |
|
|
|
889 |
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
19,604 |
|
|
$ |
24,181 |
|
|
$ |
28,274 |
|
|
|
|
|
|
|
|
|
|
|
Cost of revenues:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cryoablation disposable products and procedure fees
|
|
$ |
10,626 |
|
|
$ |
13,330 |
|
|
$ |
15,278 |
|
|
Cryocare surgical systems
|
|
|
466 |
|
|
|
255 |
|
|
|
460 |
|
|
Cardiac products (CryoCath)
|
|
|
399 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
11,491 |
|
|
$ |
13,585 |
|
|
$ |
15,738 |
|
|
|
|
|
|
|
|
|
|
|
Cost of revenues for cryoablation disposable products and
procedure fees are combined for reporting purposes. Sales of
cryoablation disposable products and procedure fees incorporate
similar inventory when sold and we do not separately track the
cost of disposable products sold directly to customers and those
consumed in cryoablation procedures. Procedure fees relate to
services which are provided to medical facilities upon request
to facilitate the overall delivery of the Companys
technology into the marketplace.
We recognize revenues from sales of Cryocare Surgical Systems
and disposable cryoprobes when persuasive evidence of an
arrangement exists, delivery has occurred, the fee is fixed and
determinable, and collectibility is reasonably assured. We also
contract with medical facilities for the use of the Cryocare
Surgical Systems in cryoablation treatments for which we charge
a per-procedure fee. Cryoablation services 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.
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.
The fee paid to the third-party service provider is charged to
cost of revenues when the procedure is performed and billed.
Research and development expenses include expenses associated
with the design and development of new products as well as
significant enhancements to existing products. We expense
research and development expenses when incurred. Our research
and development efforts are occasionally subject to significant
non-recurring expenses and fees that can cause some variability
in our quarterly research and development expenses.
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 and
customer service. Expenses
28
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.
Costs, expenses and other results of operations from continuing
operations for the three-year period ended December 31,
2005 are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31, | |
|
|
| |
|
|
2003 | |
|
2004 | |
|
2005 | |
|
|
| |
|
| |
|
| |
|
|
(In thousands) | |
Cost of revenues
|
|
$ |
11,491 |
|
|
$ |
13,585 |
|
|
$ |
15,738 |
|
Research and development
|
|
|
1,096 |
|
|
|
1,856 |
|
|
|
2,283 |
|
Sales and marketing
|
|
|
16,097 |
|
|
|
13,354 |
|
|
|
13,001 |
|
General and administrative
|
|
|
25,791 |
|
|
|
16,379 |
|
|
|
13,858 |
|
Goodwill impairment and other charges
|
|
|
|
|
|
|
9,900 |
|
|
|
26 |
|
(Gain) loss on divestitures, net
|
|
|
(9,979 |
) |
|
|
711 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total costs and expenses
|
|
$ |
44,496 |
|
|
$ |
55,785 |
|
|
$ |
44,906 |
|
|
|
|
|
|
|
|
|
|
|
Interest income
|
|
$ |
587 |
|
|
$ |
293 |
|
|
$ |
308 |
|
Interest expense
|
|
$ |
(39 |
) |
|
$ |
(7 |
) |
|
$ |
657 |
|
Minority interests
|
|
$ |
(619 |
) |
|
$ |
(583 |
) |
|
$ |
|
|
|
|
|
Year Ended December 31, 2005 Compared to Year Ended
December 31, 2004 |
Revenues. Revenues for the year ended December 31,
2005 increased $4.1 million to $28.3 million from
$24.1 million in 2004 representing an increase of
16.9 percent. The increase in revenues was primarily
attributable to growth in sales of disposables and procedure
fees.
The number of cryosurgical procedures performed, and related
sales of disposable products used in these procedures, increased
35.9 percent to 6,407 in 2005 from 4,713 in 2004, while the
related revenues increased 20.2 percent to
$26.6 million in 2005 from $22.1 million in 2004.
Contributing to growth in sales of cryosurgical products was an
increase in direct sales both in urology and interventional
radiology. Since the revenue for a sale of cryoablation
disposable products is less on average than a cryoablation
procedure fee, as the percentage of cases derived from sales of
cryosurgical disposable products increases relative to cases
derived from cryoablation procedure fees (where we are
responsible for providing the service element of the procedure),
our incremental revenues grow at a slower rate than our overall
procedure growth. However, the gross profit realized is
equivalent since we do not incur fees to third party service
providers for a sale of cryoablation disposable products.
CryoCath royalty revenues also increased 41.3 percent or
$0.3 million compared to 2004 while revenues from Cryocare
Surgical Systems decreased by 47.0 percent or
$0.7 million due to our strategy of promoting adoption of
our technology through emphasis on growth in cryoablation
procedures, rather than through sales of capital equipment.
Cost of Revenues. Cost of revenues for 2005 increased
15.9 percent to $15.7 million compared to
$13.6 million for 2004. Cost of revenues related to our
cryosurgical probes and procedures increased 14.7 percent
to $15.3 million for 2005 from $13.3 million in 2004.
The increase in cost of revenues resulted primarily from growth
in sales of cryosurgical probes and procedures. In addition,
this increase was driven by an increase in the number of
cryoablation procedures for which we bill a procedure fee and
subcontract the
29
service to third party service providers at an additional cost.
While the frequency of fees paid to third party service
providers increased, the percentage of total cryoablation
procedures requiring these services declined and the average
service fee per procedure was reduced by 15.3 percent. Cost
of revenues increases were also partially offset by the
continued reductions in manufacturing costs for our cryoablation
disposable products.
Gross Margins. Gross margins on revenues increased to
44.2 percent for 2005 compared to 43.7 percent for
2004 as a result of the cost of revenues factors outlined above.
Research and Development Expenses. Research and
development expenses for 2005 increased 23.0 percent to
$2.3 million compared to $1.9 million for 2004. The
increase was primarily attributable to increased costs
associated with several new development projects that we have
undertaken in our efforts to reduce the manufacturing costs of
the disposable components used in cryoablation surgical
procedures as well as efforts to broaden the application of
cryoablation outside of our current markets in urology and
interventional radiology. As a percentage of revenues, research
and development expenses increased to 8.1 percent in 2005
from 7.7 percent for 2004.
Selling and Marketing Expenses. Selling and marketing
expenses for 2005 decreased 2.6 percent to
$13.0 million compared to $13.4 million for 2004. The
decrease in sales and marketing expenses were primarily due to
improved management of our proctoring program which reduced
expenses by $0.3 million by being more selective in the
physicians we allow to be proctored as well as reducing the cost
of each individual proctoring event. The decrease in selling and
marketing expenses was also due to reduced severance expense in
the amount of $0.2 million, offset by an increase in
commissions expense of $0.2 million.
General and Administrative Expenses. General and
administrative expenses for 2005 decreased 15.4 percent to
$13.9 million compared to $16.4 million for 2004.
Legal and accounting costs incurred during 2005 in connection
with our historical accounting and financial reporting declined
to $3.6 million from $7.1 million. Included in the
$3.6 million were $1.3 million of costs related to our
efforts to comply with Section 404 of Sarbanes-Oxley.
Included in the $7.1 million from 2004 were
$2.3 million of costs related to our Sarbanes-Oxley
compliance efforts. The reductions in legal and accounting
expenses were partially offset by $0.6 million of
liquidated damages related to the delay in the SEC declaring
effective our
Form S-2
registration statement related to our March 2005 private
placement.
Goodwill Impairment and Other Charges. During the year
ended 2005, we recorded $26,000 to write down a partnership
interest in the mobile prostate treatment business to fair
value. During 2004, we had recorded $9.9 million in
impairment charges to write down the goodwill and amortizable
intangibles in conjunction with our ownership interests in
certain mobile prostate treatment businesses. We also recorded a
charge of $5.9 million to write down the goodwill and
intangible assets of Timm Medical in 2004, which is included in
loss from discontinued operations.
Interest Income. Interest income for 2005 was unchanged
at $0.3 million compared to 2004, and represents interest
income on interest-bearing cash accounts as well as interest
received on the promissory note from SRS Medical Corp. in
connection with the sale of the urodynamics and urinary
incontinence products lines by Timm Medical in 2003.
Interest Expense. Interest expense was negative for 2005
in the amount of $0.7 million and relates to the net
decrease in the fair market value of common stock warrants
issued in connection with our March 2005 private placement.
Loss from Continuing Operations. Loss from continuing
operations for 2005 was $14.8 million or $0.51 per
basic and diluted share on 28,977,822 weighted average shares
outstanding, compared to a loss of $31.9 million, or
$1.31 per basic and diluted share on 24,262,868 weighted
average shares outstanding for 2004.
Income (Loss) from Discontinued Operations. On
February 10, 2006, we closed the sale of our wholly-owned
subsidiary, Timm Medical, to UK-based Plethora Solutions
Holdings plc. Proceeds from the sale were $9.5 million,
consisting of $8.1 million in cash and a
24-month convertible
promissory note of $1.4 million. Revenues for Timm Medical
for the year ended December 31, 2005 were
$9.3 million. Income before taxes
30
was $2.0 million and net income was $1.2 million for
2005. In 2004, Timm Medical reported a loss of
$5.7 million, after the $5.9 million impairment charge.
|
|
|
Year Ended December 31, 2004 Compared to Year Ended
December 31, 2003 |
Revenues. Revenues for the year ended December 31,
2004 increased $4.6 million to $24.2 million from
$19.6 million in 2003 representing an increase of
23.4 percent. The increase in revenues was primarily
attributable to growth in sales of disposables and procedure
fees related to our cryosurgical business.
The number of cryosurgical procedures performed, and related
sales of disposable products used in these procedures, increased
34.5 percent to 4,713 in 2004 from 3,504 in 2003, while the
related revenues increased 23.5 percent to
$22.1 million in 2004 from $17.9 million in 2003.
Contributing to growth in sales of cryosurgical products was an
increase in procedures performed by interventional radiologists,
treating tumors in lung and liver cancers and pain resulting
from bone metastases. These 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.
Cost of Revenues. Cost of revenues for 2004 increased
18.2 percent to $13.6 million compared to
$11.5 million for 2003. The increase in cost of revenues
resulted primarily from growth in sales of cryosurgical probes
and procedures, offset by the elimination of costs related to
CryoCath revenue. Cost of revenues related to our cryosurgical
probes and procedures increased 25.5 percent to
$13.3 million for 2004 from $10.6 million in 2003. The
cost of revenues increase was also partly driven by an increase
in the percentage of total cryosurgical procedures for which we
subcontract a portion of the service to third party service
providers at an additional cost.
Gross Margins. Gross margins on revenues increased to
43.8 percent for 2004 compared to 41.4 percent for
2003 due to the elimination of costs on revenue from CryoCath
and higher margins on our sales of Cryocare Surgical Systems.
Gross margin from sales of Cryocare Surgical Systems increased
in 2004, primarily resulting from payments received during 2004
for systems which had been excluded from revenues in prior years
under our revenue recognition policies and due to amortization
of deferred systems revenues. The associated cost of revenues
from these prior year sales were recorded at the time of sale.
Research and Development Expenses. Research and
development expenses for 2004 increased 69.4 percent to
$1.9 million compared to $1.1 million for 2003. The
increase was primarily attributable to increased costs
associated with several new development projects that we have
undertaken in our efforts to reduce the manufacturing costs of
the disposable components used in cryoablation surgical
procedures. As a percentage of revenues, research and
development expenses increased to 7.7 percent in 2004 from
5.6 percent for 2003.
Selling and Marketing Expenses. Selling and marketing
expenses for 2004 decreased 17.0 percent to
$13.4 million compared to $16.1 million for 2003. The
decrease reflects a $2.4 million reduction due to our June
2004 cost reduction program. We consolidated certain sales
functions and territories, streamlined our corporate
organizational structure, reduced staff, eliminated certain
marketing activities and restructured our sales and marketing
programs.
General and Administrative Expenses. General and
administrative expenses for 2004 decreased 36.5 percent to
$16.4 million compared to $25.8 million for 2003.
Legal and accounting costs incurred during 2004 in connection
with investigations into our historical accounting and financial
reporting declined to $7.1 million from $14.3 million
in 2003. Included in the $7.1 million in 2004 were
$2.3 million of costs related to our efforts to comply with
section 404 of Sarbanes-Oxley. Included in the
$14.3 million from 2003 was $3.6 million for severance
and stock compensation expense (of which $1.8 million was a
non-cash charge for equity based compensation) related primarily
to the termination of our then chief executive officer and chief
financial officer. The remaining decrease includes a
$1.1 million reduction in bad debt expense.
Goodwill Impairment and Other Charges. During the year
ended 2004, we recorded $9.9 million in impairment charges
to write down the goodwill and amortizable intangibles in
conjunction with our ownership interests in certain mobile
prostate treatment businesses. The charge represents the excess
of the carrying value of these entities compared to their fair
value, less estimated costs to sell. Fair value for the mobile
31
prostate treatment businesses was based on a proposed purchase
offer. We also recorded an impairment charge of
$5.9 million in 2004 to reduce the goodwill and intangibles
of Timm Medical (included in discontinued operations).
Gain (Loss) on Divestitures, Net. In 2004 we recorded a
net loss of $0.7 million related to the divestiture of our
ownership interests in certain mobile prostate businesses. In
2003 we recorded a net gain of $10.0 million related to the
licensing of our intellectual property and manufacturing rights
for our SurgiFrost line, and sale of inventory and other assets
to CryoCath. We also recorded losses of $1.3 million
related to the divestiture of several non-core product lines of
Timm Medical (included in discontinued operations).
Interest Income. Interest income for 2004 was
$0.3 million compared to $0.6 million for 2003. The
decrease in interest income in 2004 compared to 2003 resulted
from a decline in our average cash balance.
Minority Interests. Minority interests represent earnings
attributable to minority investors in the mobile prostate
treatment businesses we acquired in 2002. The amounts recorded
for minority interests were $0.6 million for 2004 and 2003.
Revenues and earnings from these businesses remained consistent
with our overall operations. We sold our interests in these
mobile prostate treatment businesses effective December 31,
2004.
Loss from Continuing Operations. Net loss from continuing
operations for 2004 was $31.9 million or $1.31 per
basic and diluted share on 24,262,868 weighted average shares
outstanding, compared to a loss of $25.0 million, or
$1.03 per basic and diluted share on 24,162,090 weighted
average shares outstanding for 2003.
Income (Loss) from Discontinued Operations. Revenues for
Timm Medical for the year ended December 31, 2004 were
$8.5 million. Timm Medical reported a loss of
$0.5 million in 2003 and $5.7 million for 2004. The
2004 loss includes a $5.9 million impairment charge.
Liquidity and Capital Resources
Since inception, we have incurred losses from operations and
have reported negative cash flows. As of December 31, 2005,
we had an accumulated deficit of approximately
$165.7 million and cash and cash equivalents of
approximately $8.1 million.
We do not expect to reach break-even or cash flow positive in
2006, and we expect to continue to generate losses from
operations for the foreseeable future. These losses, which are
expected to decline, have resulted in part from our continued
investment to gain acceptance of our technology. Sales of
cryoablation disposable products and cryoablation procedure fees
represented 94.0 percent of total revenues in 2005 compared
to 91.5 percent of total revenues in 2003, and increased
48.2 percent from $17.9 million in 2003 to
$26.6 million in 2005, providing evidence that our strategy
is working. We also continue to incur significant costs
associated with ongoing investigations and other matters related
to historical accounting and financial reporting, including
obligations to indemnify our former officers and directors in
connection with those investigations. These costs, primarily
legal, audit and accounting support fees, totaled
$3.6 million, $7.1 million and
$14.3 million (net of insurance reimbursement) for the
years 2005, 2004 and 2003, respectively. For the years ended
December 31, 2005 and 2004, $1.3 million and
$2.3 million of these costs, respectively, also related to
our efforts to achieve compliance with Section 404 of
Sarbanes-Oxley. We also face large cash expenditures in the
future related to past due sales and use tax obligations, which
we estimate amounted to $2.9 million and which was accrued
as of December 31, 2005. We are in the process of
negotiating resolutions of the past due state and local tax
obligations with the applicable tax authorities.
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 an aggregate cash
purchase price of $15.6 million ($2.77 per share), in
a private placement to a syndicate of institutional investors as
well as our chief executive officer, our president and a
non-employee director.
32
On February 10, 2006, we closed the sale to Plethora
Solutions Holdings plc of all of the stock of our wholly-owned
subsidiary, Timm Medical, in exchange for:
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$8,075,000 in cash paid to us on February 10, 2006; and |
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$1,425,000 in the form of a secured convertible promissory note
due and payable in full, together with all accrued interest, on
the date 24 months or, under certain circumstances,
15 months following the closing date of the transaction,
bearing interest at 5 percent per annum. |
The proceeds from our sale of Timm Medical provide an important
cash infusion in the short term. However, Timm Medicals
operations were profitable and generated cash. Accordingly, we
expect that, as a result of the sale, we will incur greater
losses and experience greater cash use until our ongoing
operations are able to offset the effects of the sale.
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 and renal cancers, 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, the net proceeds from the
private placement and the sale of Timm Medical described above
to finance our projected operating and cash flow needs, along
with continued expense management efforts. In addition, we may
borrow funds under our line of credit with Silicon Valley Bank.
This line of credit permits us to borrow up to the lesser of
$4.0 million or amounts available under the Borrowing Base.
The Borrowing Base is (i) 80 percent of
our eligible accounts receivable, plus (ii) the lesser of
30 percent of the value of our eligible inventory or
$500,000. To date, we have not borrowed any amounts under this
line of credit.
Contractual Obligations
In the table below, we set forth our contractual obligations as
of December 31, 2005. Some of the figures we include in
this table are based on managements estimates and
assumptions about these obligations, including their duration,
the possibility of renewal, anticipated actions by third
parties, and other factors. Because these estimates and
assumptions are necessarily subjective, the contractual
obligations we will actually pay in future periods may vary from
those reflected in the table.
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Payments Due by Period |
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Total | |
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2006 | |
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2007-2008 | |
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2009-2010 |
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(In thousands) |
Non-cancelable operating leases(1)
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$ |
686 |
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$ |
553 |
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$ |
133 |
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$ |
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Purchase commitments(2)
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225 |
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225 |
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$ |
911 |
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$ |
778 |
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$ |
133 |
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$ |
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(1) |
We enter into operating leases in the normal course of business.
We lease office space as well as other property and equipment
under operating leases. Some lease agreements provide us with
the option to renew the lease at the end of the original term.
Our future operating lease obligations would change if we
exercised these renewal options and if we entered into
additional operating lease agreements. For more information, see
Note 13 to our Consolidated Financial Statements. |
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(2) |
These purchase commitments relate to agreements to purchase
goods or services. These obligations are not recorded in our
consolidated financial statements until contract payment terms
take effect. We expect to fund these commitments with cash flows
from operations and from cash balances on hand. The obligations
shown in the above table are subject to change based on, among
other things, our manufacturing operations not operating in the
normal course of business, the demand for our products, and the
ability of our suppliers to deliver the products or services as
promised. |
33
Critical Accounting Policies
The foregoing discussion and analysis of our financial condition
and results of operations are based on our consolidated
financial statements, which have been prepared in accordance
with U.S. generally accepted accounting principles. The
preparation of the financial statements requires management to
make estimates and assumptions in applying certain critical
accounting policies. Certain accounting estimates are
particularly sensitive because of their significance to our
consolidated financial statements and because of the possibility
that future events affecting the estimates could differ
significantly from current expectations. Factors that could
possibly cause actual amounts to differ from current estimates
relate to various risks and uncertainties inherent in our
business, including those set forth under Risks
Factors in Item 1A of this Annual Report on
Form 10-K.
Management believes that the following are some of the more
critical judgment areas in the application of accounting
policies that affect our financial statements.
Revenue Recognition. We follow the provisions of Staff
Accounting Bulletin 104, Revenue Recognition in
Financial Statements (SAB 104) and
Emerging Issues Task Force (EITF) Issue No. 00-21,
Revenue Arrangements with Multiple Deliverables for
revenue recognition. Under SAB 104, four conditions must be
met before revenue can be recognized: (i) there is
persuasive evidence that an arrangement exists,
(ii) delivery has occurred or service has been rendered,
(iii) the price is fixed or determinable and
(iv) collection is reasonably assured.
We reduce our revenues for customer concessions, and defer
revenue recognition for minimum procedure guarantees, contingent
payment arrangements and when we have continuing performance
obligations until a future date when the contingencies are
resolved and obligations met.
Where we own the equipment used in the procedure, we bill the
medical facility and retain the entire procedure fee. In many
instances, however, the equipment is owned by a third-party who
contracts with us to perform the service component of the
procedure. Third-party service providers are at times entities
owned or controlled by urologists who perform cryosurgical
procedures. In the latter case, we still invoice the medical
facility but we pay a fee to the third-party service provider.
The procedure fee is recorded as revenue in the period when the
procedure is performed and, where applicable, the fee paid to a
third-party service provider is included in cost of revenues for
the same period.
From time to time we provide loaner equipment to customers as
part of a strategy aimed at promoting broader acceptance of our
technology and driving sales of disposable products faster than
would be possible if we restricted use of the device only to
customers willing to make a significant capital investment in a
Cryocare Surgical System. In these situations, we either loan a
mobile Cryocare Surgical System to a hospital or consign a
stationary Cryocare Surgical System with the hospital under our
placement program and charge a fee for each procedure in which
the equipment is used. Cost of revenues includes depreciation on
the Cryocare Surgical Systems we own over an estimated useful
life of three years.
We routinely assess the financial strength of our customers and,
as a consequence, believe that our accounts receivable credit
risk exposure is limited. Accounts receivable are carried at
original invoice amount less all discounts and allowances, and
less an estimate for doubtful accounts and sales returns based
on a periodic review of outstanding receivables. Allowances are
provided for known and anticipated credit losses as determined
by management in the course of regularly evaluating individual
customer receivables. This evaluation takes into consideration a
customers financial condition and credit history as well
as current economic conditions. Accounts receivable are written
off when deemed uncollectible. Recoveries of accounts receivable
previously written off are recorded when received.
Goodwill Impairment. We test for goodwill impairment in
the fourth fiscal quarter of each year, or sooner if events or
changes in circumstances indicate that the carrying amount may
exceed the fair value. The goodwill impairment test is a
two-step process, which requires management to make judgments in
determining what assumptions to use in the calculation. In 2003,
we concluded that the estimated fair value of each reporting
unit exceeded the carrying amount, so goodwill was not impaired.
In 2004, we recognized impairment charges of $3.1 million
and $9.9 million to reduce the carrying value of the
goodwill acquired in the Timm Medical acquisition and equity
interests in the mobile prostate treatment businesses,
respectively.
34
Included in the 2004 impairment charge was $0.7 million of
estimated costs to sell these entities. In 2005, the only
remaining goodwill was related to Timm Medical. The Company
reviewed the purchase price of the Timm Medical divestiture from
which management concluded that goodwill was not impaired. At
December 31, 2005 the carrying value of the goodwill
related to Timm Medical was $4.6 million and is included in
assets of discontinued operations.
Impairment of Long-Lived Assets. We have a significant
amount of property, equipment and amortizable intangible assets
primarily consisting of purchased patents and acquired
technology. In accordance with Statement of Financial Accounting
Standards (SFAS) No. 144, Accounting for the
Impairment or Disposal of Long Lived Assets, we review our
long-lived assets and certain identifiable intangibles for
impairment whenever events or changes in circumstances indicate
that the carrying amount of an asset or asset group may not be
recoverable. Recoverability of long-lived and amortizable
intangible assets to be held and used is measured by a
comparison of the carrying amount of an asset to the
undiscounted future operating cash flows expected to be
generated by the asset. If such assets are considered to be
impaired, the impairment to be recognized is measured as the
amount by which the carrying value of the assets exceeds their
fair value. At December 31, 2003, we concluded that a write
down for impairment of any of our long-lived assets was not
required. In 2004, we recognized impairment charges of
$2.1 million and $80,000 to reduce the carrying value of
intangible assets acquired in the Timm Medical acquisition and
equity interests in the mobile prostate treatment businesses,
respectively.
Legal and Other Loss Contingencies. In the normal course
of business, we are subject to contingencies, such as legal
proceedings and claims arising out of our business that cover a
wide range of matters, including tax matters, product liability
and workers compensation. In accordance with
SFAS No. 5, Accounting for Contingencies, we
record accruals for such contingencies when it is probable that
a liability will be incurred and the amount of loss can be
reasonably estimated. A significant amount of management
estimation is required in determining when, or if, an accrual
should be recorded for a contingent matter and the amount of
such accrual, if any. Due to the uncertainty of determining the
likelihood of a future event occurring and the potential
financial statement impact of such an event, it is possible that
upon further development or resolution of a contingent matter, a
charge could be recorded in a future period that would be
material to our consolidated results of operations, financial
position or cash flows.
Other Investments. We review our equity investments for
impairment based on our determination of whether a decline in
market value of the investment below our carrying value is other
than temporary. In making this determination, we consider
Accounting Principles Board Opinion (APB) No. 18,
The Equity Method of Accounting of Investments in Common
Stock, which set forth factors to be evaluated in
determining whether a loss in value should be recognized.
Factors include the investees operational performance,
indicators of continued viability, financing status, liquidity
prospects and cash flow forecasts. We also consider our ability
to hold the investment until we recover our cost, the market
price and market price fluctuations of the investments
publicly traded shares and the ability of the investee to
sustain an earnings capacity which would justify the carrying
amount of the investment.
Income Taxes. In the preparation of our consolidated
financial statements, we are required to estimate income taxes
in each of the jurisdictions in which we operate, including
estimating both actual current tax exposure and assessing
temporary differences resulting from differing treatment of
items for tax and accounting purposes. Assessment of actual
current tax exposure includes assessing tax strategies, the
status of tax audits and open audit periods with the taxing
authorities. To the extent that we have deferred tax assets, we
must assess the likelihood that our deferred tax assets will be
recovered from taxable temporary differences, tax strategies or
future taxable income and to the extent that we believe that
recovery is not likely, we must establish a valuation allowance.
As of December 31, 2005 we have established a valuation
allowance of $63.5 million against our deferred tax assets.
In the future, we may adjust our estimates of the amount of
valuation allowance needed and such adjustment would impact our
provision for income taxes in the period of such change.
35
Inflation
The impact of inflation on our business has not been significant
to date.
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Item 7A. |
Quantitative and Qualitative Disclosures About Market
Risk |
The primary objective of our investment activities is to
preserve principal while at the same time maximizing the income
we receive from our invested cash without significantly
increasing risk of loss. Our financial instruments include cash,
cash equivalents, accounts and notes receivable, investments,
accounts payable and accrued liabilities. As of
December 31, 2005, the carrying values of these 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.
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Item 8. |
Financial Statements and Supplementary Data |
Our financial statements and schedules, as listed under
Item 15, appear in a separate section of this Annual Report
on Form 10-K
beginning on page F-1.
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Item 9. |
Changes in and Disagreements With Accountants on
Accounting and Financial Disclosure |
Not applicable.
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Item 9A. |
Controls and Procedures |
(a) Evaluation of Disclosure Controls and
Procedures. We maintain disclosure controls and procedures
that are designed to ensure that information required to be
disclosed in our reports pursuant to the Securities Exchange Act
of 1934, as amended, is recorded, processed, summarized and
reported within the time periods specified in the SECs
rules and forms and that such information is accumulated and
communicated to our management, including our chief executive
officer and chief financial officer, as appropriate, to allow
for timely decisions regarding required disclosure. In designing
and evaluating the disclosure controls and procedures,
management recognizes that any controls and procedures, no
matter how well designed and operated, can provide only
reasonable assurance of achieving the desired control
objectives, and management is required to apply its judgment in
evaluating the cost-benefit relationship of possible controls
and procedures.
As required by
Rule 13a-15(b) of
the Securities Exchange Act of 1934, as amended, we carried out
an evaluation, under the supervision and with the participation
of our management, including our chief executive officer and
chief financial officer, of the effectiveness of the design and
operation of our disclosure controls and procedures as of the
end of the period 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 a reasonable assurance level.
(b) Managements Annual Report on Internal Control
Over Financial Reporting. Management of the company is
responsible for establishing and maintaining adequate internal
control over financial reporting as defined in
Rules 13a-15(f)
and 15d-15(f) under the
Securities Exchange Act of 1934. Our internal control over
financial reporting is designed to provide reasonable assurance
regarding the reliability of financial reporting and the
preparation of financial statements for external purposes in
accordance with generally
36
accepted accounting principles. Our internal control over
financial reporting includes those policies and procedures that:
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(i) pertain to the maintenance of records that, in
reasonable detail, accurately and fairly reflect the
transactions and dispositions of the assets of the company; |
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(ii) provide reasonable assurance that transactions are
recorded as necessary to permit preparation of financial
statements in accordance with generally accepted accounting
principles, and that receipts and expenditures of the company
are being made only in accordance with authorizations of
management and directors of the company; and |
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(iii) provide reasonable assurance regarding prevention or
timely detection of unauthorized acquisition, use or disposition
of the companys assets that could have a material effect
on the financial statements. |
Because of its inherent limitations, internal control over
financial reporting may not prevent or detect misstatements.
Also, projections of any evaluation of effectiveness to future
periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree
of compliance with the policies or procedures may deteriorate.
Management assessed the effectiveness of the companys
internal control over financial reporting as of
December 31, 2005. In making this assessment, management
used the criteria set forth by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO) in Internal
Control Integrated Framework.
Based on our assessment and those criteria, management believes
that the company maintained effective internal control over
financial reporting as of December 31, 2005.
The companys independent registered public accounting firm
has issued an attestation report on managements assessment
of the companys internal control over financial reporting.
That report appears below in this Item 9A.
(c) Changes in Internal Controls. There was no
change in our internal control over financial reporting during
our fourth fiscal quarter for 2005 that has materially affected,
or is reasonably likely to materially affect, our internal
control over financial reporting.
37
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
ON INTERNAL CONTROL OVER FINANCIAL REPORTING
To the Board of Directors
Endocare, Inc.
We have audited managements assessment, included in the
accompanying Managements Annual Report on Internal Control
Over Financial Reporting, that Endocare, Inc. (Endocare)
maintained effective internal control over financial reporting
as of December 31, 2005, based on criteria established in
Internal Control Integrated Framework issued
by the Committee of Sponsoring Organizations of the Treadway
Commission (the COSO criteria). Endocares management is
responsible for maintaining effective internal control over
financial reporting and for its assessment of the effectiveness
of internal control over financial reporting. Our responsibility
is to express an opinion on managements assessment and an
opinion on the effectiveness of Endocares internal control
over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the
Public Company Accounting Oversight Board (United States). Those
standards require that we plan and perform the audit to obtain
reasonable assurance about whether effective internal control
over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of
internal control over financial reporting, evaluating
managements assessment, testing and evaluating the design
and operating effectiveness of internal control, and performing
such other procedures as we considered necessary in the
circumstances. We believe that our audit provides a reasonable
basis for our opinion.
A companys internal control over financial reporting is a
process designed to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of
financial statements for external purposes in accordance with
generally accepted accounting principles. A companys
internal control over financial reporting includes those
policies and procedures that (1) pertain to the maintenance
of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the
company; (2) provide reasonable assurance that transactions
are recorded as necessary to permit preparation of financial
statements in accordance with generally accepted accounting
principles, and that receipts and expenditures of the company
are being made only in accordance with authorizations of
management and directors of the company; and (3) provide
reasonable assurance regarding prevention or timely detection of
unauthorized acquisition, use, or disposition of the
companys assets that could have a material effect on the
financial statements.
Because of its inherent limitations, internal control over
financial reporting may not prevent or detect misstatements.
Also, projections of any evaluation of effectiveness to future
periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree
of compliance with the policies or procedures may deteriorate.
In our opinion, managements assessment that Endocare
maintained effective internal control over financial reporting
as of December 31, 2005, is fairly stated, in all material
respects, based on the COSO criteria. Also, in our opinion,
Endocare maintained, in all material respects, effective
internal control over financial reporting as of
December 31, 2005, based on the COSO criteria.
We have also audited, in accordance with the standards of the
Public Company Accounting Oversight Board (United States), the
consolidated balance sheets of Endocare as of December 31,
2004 and 2005, and the related consolidated statements of
operations, stockholders equity, and cash flows for each
of the three years in the period ended December 31, 2005 of
Endocare, Inc. and our report dated March 8, 2006,
expressed an unqualified opinion thereon.
Los Angeles, California
March 8, 2006
38
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Item 9B. |
Other Information |
Not applicable.
PART III
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Item 10. |
Directors and Executive Officers of the Registrant |
The information required by this Item 10 is incorporated by
reference to the Definitive Proxy Statement relating to our 2006
Annual Meeting of Stockholders, which we expect to file within
120 days after the end of our fiscal year ended
December 31, 2005.
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Item 11. |
Executive Compensation |
The information required by this Item 11 is incorporated by
reference to the Definitive Proxy Statement relating to our 2006
Annual Meeting of Stockholders, which we expect to file within
120 days after the end of our fiscal year ended
December 31, 2005.
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Item 12. |
Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters |
The information required by this Item 12 is incorporated by
reference to the Definitive Proxy Statement relating to our 2006
Annual Meeting of Stockholders, which we expect to file within
120 days after the end of our fiscal year ended
December 31, 2005.
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Item 13. |
Certain Relationships and Related Transactions |
The information required by this Item 13 is incorporated by
reference to the Definitive Proxy Statement relating to our 2006
Annual Meeting of Stockholders, which we expect to file within
120 days after the end of our fiscal year ended
December 31, 2005.
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Item 14. |
Principal Accountant Fees and Services |
The information required by this Item 14 is incorporated by
reference to the Definitive Proxy Statement relating to our 2006
Annual Meeting of Stockholders, which we expect to file within
120 days after the end of our fiscal year ended
December 31, 2005.
39
PART IV
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Item 15. |
Exhibits and Financial Statement Schedules |
(a)(1) Financial Statements:
The Consolidated Financial Statements of the Company are
included in a separate section of this Annual Report on
Form 10-K
commencing on the pages referenced below:
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Page |
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Consolidated Financial Statements of the Company:
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F-1 |
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F-2 |
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F-3 |
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F-4 to F-5 |
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F-6 |
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F-7 to F-34 |
(2) Financial Statement Schedules:
Schedule II Valuation and Qualifying Accounts
for the years ended December 31, 2003, 2004 and 2005 is
included in the Consolidated Financial Statements at
page F-35. All
other schedules have been omitted because they are not
applicable, not required or the information is included in the
consolidated financial statements or the notes thereto.
(3) Exhibit:
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Exhibit No. |
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Description |
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2 |
.1(1) |
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Partnership Interest Purchase Agreement, dated as of
December 30, 2004, by and between the Company and Advanced
Medical Partners, Inc. |
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2 |
.2(2) |
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Stock Purchase Agreement, dated as of January 13, 2006, by
and among Plethora Solutions Holdings plc, Endocare, Inc. and
Timm Medical Technologies, Inc. The schedules and other
attachments to this exhibit were omitted. The Company agrees to
furnish a copy of any omitted schedules or attachments to the
Securities and Exchange Commission upon request. |
|
2 |
.3 |
|
$1,425,000 Secured Convertible Promissory Note, dated as of
February 10, 2006, from Plethora Solutions Holdings plc to
Endocare, Inc. |
|
3 |
.1(3) |
|
Certificate of Amendment of Restated Certificate of
Incorporation of the Company. |
|
3 |
.2(3) |
|
Certificate of Designation of Series A Junior Participating
Preferred Stock of the Company. |
|
3 |
.3(3) |
|
Restated Certificate of Incorporation. |
|
3 |
.4(4) |
|
Amended and Restated Bylaws of the Company. |
|
4 |
.1(5) |
|
Form of Stock Certificate. |
|
4 |
.2(6) |
|
Form of Series A Warrant. |
|
4 |
.3(6) |
|
Form of Series B Warrant. |
|
4 |
.4(7) |
|
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(8) |
|
Amendment No. 1 to Rights Agreement, dated as of
September 24, 2005, between the Company and U.S. Stock
Transfer Corporation. |
40
|
|
|
|
|
Exhibit No. |
|
Description |
|
|
|
|
10 |
.1(9) |
|
Lease Agreement, dated November 26, 2001 by and between the
Company and the Irvine Company. |
|
10 |
.2(9) |
|
Form of Indemnification Agreement by and between the Company and
its directors. |
|
10 |
.3(9) |
|
Form of Indemnification Agreement by and between the Company and
its executive officers. |
|
10 |
.4(10) |
|
1995 Director Option Plan (as amended and restated through
March 2, 1999). |
|
10 |
.5(11) |
|
1995 Stock Plan (as amended and restated through
December 30, 2003). |
|
10 |
.6(12) |
|
2002 Supplemental Stock Plan. |
|
10 |
.7(12) |
|
2002 Executive Separation Benefits Plan. |
|
10 |
.8(13) |
|
Employment Agreement, dated as of March 3, 2003, by and
between the Company and William J. Nydam. |
|
10 |
.9(14) |
|
Consulting Agreement, dated as of August 27, 2003, by and
between the Company and Craig T. Davenport. |
|
10 |
.10(15) |
|
Employment Agreement, dated as of December 15, 2003, by and
between the Company and Craig T. Davenport. |
|
10 |
.11(16) |
|
Employment Agreement, dated as of August 11, 2004, by and
between the Company and Michael R. Rodriguez. |
|
10 |
.12(17) |
|
2004 Stock Incentive Plan. |
|
10 |
.13(18) |
|
2004 Non-Employee Director Option Program under 2004 Stock
Incentive Plan. |
|
10 |
.14(18) |
|
Form of Award Agreement Under 2004 Stock Incentive Plan. |
|
10 |
.15(18) |
|
Stipulation of Settlement, dated as of November 1, 2004,
relating to securities class action lawsuit. |
|
10 |
.16(18) |
|
Description of Craig Davenport salary adjustment, effective
December 2004. |
|
10 |
.17(18) |
|
Confidential Settlement Agreement and Release, dated as of
December 14, 2004, by and between the Company and certain
Underwriters at Lloyds, London. |
|
10 |
.18(18) |
|
Release and Settlement Agreement, dated as of December 16,
2004, by and between the Company and National Union Fire
Insurance Company. |
|
10 |
.19(19) |
|
Description of William J. Nydam salary adjustment, effective
February 2005. |
|
10 |
.20(19) |
|
Description of Michael R. Rodriguez salary adjustment, effective
February 2005. |
|
10 |
.21(19) |
|
Confidential Settlement Agreement and Release, dated as of
February 18, 2005, by and between the Company and Great
American E&S Insurance Company. |
|
10 |
.22(20) |
|
2004 Management Incentive Compensation Program. |
|
10 |
.23(20) |
|
2005 Management Incentive Compensation Program. |
|
10 |
.24(6) |
|
Purchase Agreement, dated as of March 10, 2005, by and
between the Company and the Investors (as defined therein). |
|
10 |
.25(6) |
|
Registration Rights Agreement, dated as of March 10, 2005,
by and between Endocare and the Investors (as defined therein). |
|
10 |
.26(21) |
|
First Amendment to Employment Agreement with Craig T. Davenport,
dated as of April 28, 2005. |
|
10 |
.27(22) |
|
Description of director compensation, as amended on
September 14, 2005. |
|
10 |
.28 |
|
Loan and Security Agreement, dated as of October 26, 2005,
by and among Endocare, Inc., Timm Medical Technologies, Inc. and
Silicon Valley Bank. |
|
10 |
.29 |
|
Commercialization Agreement, dated as of November 8, 2005,
by and between Endocare, Inc. and CryoDynamics, LLC. |
|
10 |
.30 |
|
Confidential Settlement Agreement and Release, dated as of
December 1, 2005, by and between Endocare, Inc. and Liberty
Mutual Insurance Company. |
|
21 |
.1(23) |
|
Subsidiaries of Registrant. |
|
23 |
.1 |
|
Consent of Independent Registered Public Accounting Firm. |
41
|
|
|
|
|
Exhibit No. |
|
Description |
|
|
|
|
24 |
.1 |
|
Power of Attorney, included on signature page. |
|
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. |
|
|
|
|
|
Management contract or compensatory plan or arrangement. |
|
|
(1) |
Previously filed as an exhibit to our
Form 8-K filed on
January 6, 2005. |
|
(2) |
Previously filed as an exhibit to our
Form 8-K filed on
January 18, 2006. |
|
(3) |
Previously filed as an exhibit to our Registration Statement on
Form S-3 filed on
September 20, 2001. |
|
(4) |
Previously filed as an exhibit to our
Form 10-K filed on
March 15, 2004. |
|
(5) |
Previously filed as an exhibit to our
Form 10-K for the
year ended December 31, 1995. |
|
(6) |
Previously filed as an exhibit to our
Form 8-K filed on
March 16, 2005. |
|
(7) |
Previously filed as an exhibit to our
Form 8-K filed on
June 3, 1999. |
|
(8) |
Previously filed as an exhibit to our
Form 8-K filed on
June 28, 2005. |
|
(9) |
Previously filed as an exhibit to our
Form 10-K filed on
March 29, 2002. |
|
|
(10) |
Previously filed as an exhibit to our Registration Statement on
Form S-8 filed on
June 2, 1999. |
|
(11) |
Previously filed as an appendix to our Definitive Proxy
Statement filed on December 3, 2003. |
|
(12) |
Previously filed as an exhibit to our
Form 10-K filed on
December 3, 2003. |
|
(13) |
Previously filed as an exhibit to our
Form 8-K filed on
March 27, 2003. |
|
(14) |
Previously filed as an exhibit to our
Form 10-K filed on
March 15, 2004. |
|
(15) |
Previously filed as an exhibit to our
Form 8-K filed on
December 16, 2003. |
|
(16) |
Previously filed as an exhibit to our
Form 8-K filed on
August 12, 2004. |
|
(17) |
Previously filed as an appendix to our Definitive Proxy
Statement filed on August 6, 2004. |
|
(18) |
Previously filed as an exhibit to our
Form 10-K filed on
March 16, 2005. |
|
(19) |
Previously filed as an exhibit to our
Form 10-Q filed on
May 10, 2005. |
|
(20) |
Previously filed as an exhibit to our
Form 8-K filed on
March 1, 2005. |
|
(21) |
Previously filed as an exhibit to our
Form 8-K filed on
May 3, 2005. |
|
(22) |
Previously filed as an exhibit to our
Form 8-K filed on
September 16, 2005. Our director compensation program was
subsequently amended on February 23, 2006, as described in
our Form 8-K filed
on March 1, 2006. |
|
(23) |
Not applicable because, as a result of our sale of Timm Medical
on February 10, 2006, we do not have any subsidiaries that
constitute significant subsidiaries under
Rule 1-02(w) of
Regulation S-X.
|
Supplemental Information
We have not sent an annual report or proxy materials to our
stockholders as of the date of this Annual Report on
Form 10-K. We
intend to provide our stockholders with an annual report and
proxy materials after the filing of this Annual Report on
Form 10-K, and we
will furnish the annual report to the SEC at that time.
42
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the
Securities Exchange Act of 1934, the registrant has duly caused
this report to be signed on its behalf by the undersigned
thereunto duly authorized.
Date: March 16, 2006
|
|
|
|
By: |
/s/ Craig T. Davenport |
|
|
|
|
|
Craig T. Davenport |
|
Chairman and Chief Executive Officer |
POWER OF ATTORNEY
Know all men by these presents, that each person whose signature
appears below constitutes and appoints Craig T. Davenport
and Michael R. Rodriguez, and each or any one of them, his
true and lawful
attorney-in-fact and
agent, with full power of substitution, for him and in his name,
place and stead, in any and all capacities, to sign any and all
amendments to this Annual Report on
Form 10-K, and to
file the same, with all exhibits thereto, and other documents in
connection therewith, with the SEC, granting unto said
attorneys-in-fact and
agents, and each of them, full power and authority to do and
perform each and every act and thing requisite and necessary to
be done in connection therewith, as fully to all intents and
purposes as he might or could do in person, hereby ratifying and
confirming all that said
attorneys-in-fact and
agents, or any of them, or their or his substitutes or
substitute, may lawfully do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of
1934, this report has been signed below by the following persons
on behalf of the registrant and in the capacities and on the
dates indicated.
|
|
|
|
|
|
|
Signature |
|
Title |
|
Date |
|
|
|
|
|
|
/s/ Craig T. Davenport
Craig T. Davenport |
|
Chairman and Chief Executive Officer (principal executive
officer) |
|
March 16, 2006 |
|
/s/ Michael R.
Rodriguez
Michael R. Rodriguez |
|
Senior Vice President, Finance and Chief Financial Officer
(principal financial and accounting officer) |
|
March 16, 2006 |
|
/s/ John R.
Daniels, M.D.
John R. Daniels, M.D. |
|
Director |
|
March 16, 2006 |
|
/s/ David L. Goldsmith
David L. Goldsmith |
|
Director |
|
March 16, 2006 |
|
/s/ Eric S. Kentor
Eric S. Kentor |
|
Director |
|
March 16, 2006 |
|
/s/ Terrence A. Noonan
Terrence A. Noonan |
|
Director |
|
March 16, 2006 |
|
/s/ Michael J.
Strauss, M.D.
Michael J. Strauss, M.D. |
|
Director |
|
March 16, 2006 |
|
/s/ Thomas R. Testman
Thomas R. Testman |
|
Director |
|
March 16, 2006 |
43
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors
Endocare, Inc.
We have audited the accompanying consolidated balance sheets of
Endocare, Inc. (the Company) and subsidiaries as of
December 31, 2004 and 2005, and the related consolidated
statements of operations, stockholders equity, and cash
flows for each of the three years in the period ended
December 31, 2005. Our audits also included the financial
statement schedule listed in the Index at Item 15(a). These
financial statements and schedule are the responsibility of the
Companys management. Our responsibility is to express an
opinion on these financial statements and schedule based on our
audits.
We conducted our audits in accordance with the standards of the
Public Company Accounting Oversight Board (United States). Those
standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are
free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the
accounting principles used and significant estimates made by
management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above
present fairly, in all material respects, the consolidated
financial position of Endocare, Inc. and subsidiaries at
December 31, 2004 and 2005, and the consolidated results of
their operations and their cash flows for each of the three
years in the period ended December 31, 2005, in conformity
with U.S. generally accepted accounting principles. Also in
our opinion, the related financial statement schedule, when
considered in relation to the basic financial statements taken
as a whole, presents fairly in all material respects the
information set forth therein.
We also have audited, in accordance with the standards of the
Public Company Accounting Oversight Board (United States), the
effectiveness of Endocare, Inc.s internal control over
financial reporting as of December 31, 2005, based on
criteria established in Internal Control Integrated
Framework issued by the Committee of Sponsoring Organizations of
the Treadway Commission and our report dated March 8, 2006
expressed an unqualified opinion thereon.
Los Angeles, California
March 8, 2006
F-1
ENDOCARE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years Ended December 31 | |
|
|
| |
|
|
2003 | |
|
2004 | |
|
2005 | |
|
|
| |
|
| |
|
| |
|
|
(In thousands, except per share data) | |
Product sales
|
|
$ |
5,226 |
|
|
$ |
6,036 |
|
|
$ |
7,605 |
|
Service revenues
|
|
|
14,378 |
|
|
|
17,516 |
|
|
|
19,780 |
|
Other
|
|
|
|
|
|
|
629 |
|
|
|
889 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
19,604 |
|
|
|
24,181 |
|
|
|
28,274 |
|
|
|
|
|
|
|
|
|
|
|
Costs and expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of revenues
|
|
|
11,491 |
|
|
|
13,585 |
|
|
|
15,738 |
|
|
Research and development
|
|
|
1,096 |
|
|
|
1,856 |
|
|
|
2,283 |
|
|
Selling and marketing
|
|
|
16,097 |
|
|
|
13,354 |
|
|
|
13,001 |
|
|
General and administrative
|
|
|
25,791 |
|
|
|
16,379 |
|
|
|
13,858 |
|
|
Goodwill impairment and other charges
|
|
|
|
|
|
|
9,900 |
|
|
|
26 |
|
|
(Gain) loss on divestitures, net
|
|
|
(9,979 |
) |
|
|
711 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total costs and expenses
|
|
|
44,496 |
|
|
|
55,785 |
|
|
|
44,906 |
|
|
|
|
|
|
|
|
|
|
|
Loss from operations
|
|
|
(24,892 |
) |
|
|
(31,604 |
) |
|
|
(16,632 |
) |
Interest income
|
|
|
587 |
|
|
|
293 |
|
|
|
308 |
|
Interest expense
|
|
|
(39 |
) |
|
|
(7 |
) |
|
|
657 |
|
|
|
|
|
|
|
|
|
|
|
Loss from continuing operations before minority interests
|
|
|
(24,344 |
) |
|
|
(31,318 |
) |
|
|
(15,667 |
) |
Minority interests
|
|
|
(619 |
) |
|
|
(583 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss from continuing operations before taxes
|
|
|
(24,963 |
) |
|
|
(31,901 |
) |
|
|
(15,667 |
) |
Tax benefit on continuing operations
|
|
|
|
|
|
|
|
|
|
|
829 |
|
|
|
|
|
|
|
|
|
|
|
Loss from continuing operations
|
|
|
(24,963 |
) |
|
|
(31,901 |
) |
|
|
(14,838 |
) |
Income (loss) from discontinued operations, net of taxes
|
|
|
(485 |
) |
|
|
(5,718 |
) |
|
|
1,159 |
|
|
|
|
|
|
|
|
|
|
|
Net loss
|
|
$ |
(25,448 |
) |
|
$ |
(37,619 |
) |
|
$ |
(13,679 |
) |
|
|
|
|
|
|
|
|
|
|
Net income (loss) per share of common stock basic
and diluted
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Continuing operations
|
|
$ |
(1.03 |
) |
|
$ |
(1.31 |
) |
|
$ |
(0.51 |
) |
|
Discontinued operations
|
|
$ |
(0.02 |
) |
|
$ |
(0.24 |
) |
|
$ |
0.04 |
|
Weighted-average shares of common stock outstanding
|
|
|
24,162 |
|
|
|
24,263 |
|
|
|
28,978 |
|
The accompanying notes are an integral part of these
Consolidated Financial Statements.
F-2
ENDOCARE, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31 | |
|
|
| |
|
|
2004 | |
|
2005 | |
|
|
| |
|
| |
|
|
(In thousands, except share | |
|
|
and per share data) | |
ASSETS |
Current assets:
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents
|
|
$ |
7,830 |
|
|
$ |
8,108 |
|
|
Accounts receivable less allowances for doubtful accounts and
sales returns of $74 and $70 at December 31, 2004 and 2005,
respectively
|
|
|
3,337 |
|
|
|
3,549 |
|
|
Inventories
|
|
|
2,828 |
|
|
|
2,462 |
|
|
Prepaid expenses and other current assets
|
|
|
1,533 |
|
|
|
1,213 |
|
|
Assets of discontinued operations
|
|
|
1,185 |
|
|
|
9,624 |
|
|
|
|
|
|
|
|
|
|
Total current assets
|
|
|
16,713 |
|
|
|
24,956 |
|
Property and equipment, net
|
|
|
2,672 |
|
|
|
1,794 |
|
Intangibles, net
|
|
|
4,390 |
|
|
|
4,167 |
|
Investments and other assets
|
|
|
1,343 |
|
|
|
1,320 |
|
Assets of discontinued operations
|
|
|
9,256 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total assets
|
|
$ |
34,374 |
|
|
$ |
32,237 |
|
|
|
|
|
|
|
|
|
LIABILITIES AND STOCKHOLDERS EQUITY |
Current liabilities:
|
|
|
|
|
|
|
|
|
|
Accounts payable
|
|
$ |
2,279 |
|
|
$ |
2,680 |
|
|
Accrued compensation
|
|
|
3,413 |
|
|
|
3,614 |
|
|
Other accrued liabilities
|
|
|
9,187 |
|
|
|
6,629 |
|
|
Liabilities of discontinued operations
|
|
|
1,855 |
|
|
|
1,461 |
|
|
|
|
|
|
|
|
|
|
Total current liabilities
|
|
|
16,734 |
|
|
|
14,384 |
|
Minority interests
|
|
|
214 |
|
|
|
|
|
Common stock warrants
|
|
|
|
|
|
|
5,023 |
|
Stockholders equity:
|
|
|
|
|
|
|
|
|
|
Preferred stock, $.001 par value; 1,000,000 shares
authorized; none issued and outstanding
|
|
|
|
|
|
|
|
|
|
Common stock, $.001 par value; 50,000,000 shares
authorized; 24,342,482 and 30,089,144 shares issued and
outstanding at December 31, 2004 and 2005, respectively
|
|
|
24 |
|
|
|
30 |
|
|
Additional paid-in capital
|
|
|
169,400 |
|
|
|
178,477 |
|
|
Accumulated deficit
|
|
|
(151,998 |
) |
|
|
(165,677 |
) |
|
|
|
|
|
|
|
|
|
Total stockholders equity
|
|
|
17,426 |
|
|
|
12,830 |
|
|
|
|
|
|
|
|
|
|
Total liabilities and stockholders equity
|
|
$ |
34,374 |
|
|
$ |
32,237 |
|
|
|
|
|
|
|
|
The accompanying notes are an integral part of these
Consolidated Financial Statements.
F-3
ENDOCARE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY
(DEFICIENCY)
(In thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accumulated | |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other | |
|
|
|
|
|
|
|
|
Common Stock | |
|
|
|
|
|
|
|
Comprehensive | |
|
|
|
|
|
Total | |
|
|
| |
|
Additional | |
|
Accumulated | |
|
Receivable From | |
|
Income, Net | |
|
Deferred | |
|
|
|
Stockholders | |
|
|
Shares | |
|
Amount | |
|
Paid-In Capital | |
|
Deficit | |
|
Stockholder | |
|
of Tax | |
|
Compensation | |
|
Treasury Stock | |
|
Equity | |
|
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Balance at December 31, 2002
|
|
|
24,148 |
|
|
|
24 |
|
|
$ |
169,935 |
|
|
$ |
(88,932 |
) |
|
$ |
(214 |
) |
|
$ |
13 |
|
|
$ |
(132 |
) |
|
$ |
(2,071 |
) |
|
$ |
78,623 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive loss:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(25,447 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(25,447 |
) |
|
Unrealized gain on available for-sale securities, net
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(13 |
) |
|
|
|
|
|
|
|
|
|
|
(13 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive loss:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(25,447 |
) |
|
|
|
|
|
|
(13 |
) |
|
|
|
|
|
|
|
|
|
|
(25,460 |
) |
Stock options exercised
|
|
|
35 |
|
|
|
|
|
|
|
23 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
23 |
|
Issuance of restricted stock
|
|
|
5 |
|
|
|
|
|
|
|
20 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
20 |
|
Compensation related to issuance of options to employees
|
|
|
|
|
|
|
|
|
|
|
1,780 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
25 |
|
|
|
|
|
|
|
1,805 |
|
Compensation related to issuance of options and warrants to
consultants for services
|
|
|
|
|
|
|
|
|
|
|
117 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
117 |
|
Treasury stock received as repayment of loan previously forgiven
|
|
|
(5 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(21 |
) |
|
|
(21 |
) |
Forgiveness of receivable from stockholder
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
214 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
214 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at December 31, 2003
|
|
|
24,183 |
|
|
$ |
24 |
|
|
$ |
171,875 |
|
|
$ |
(114,379 |
) |
|
$ |
|
|
|
$ |
|
|
|
$ |
(107 |
) |
|
$ |
(2,092 |
) |
|
$ |
55,321 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(37,619 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(37,619 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock options exercised
|
|
|
350 |
|
|
|
|
|
|
|
92 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
92 |
|
Compensation related to issuance of options and warrants
|
|
|
|
|
|
|
|
|
|
|
123 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
13 |
|
|
|
|
|
|
|
136 |
|
Treasury stock retired
|
|
|
|
|
|
|
|
|
|
|
(2,596 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2,596 |
|
|
|
|
|
Purchase of treasury stock
|
|
|
(191 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(504 |
) |
|
|
(504 |
) |
Deferred compensation on options forfeited
|
|
|
|
|
|
|
|
|
|
|
(94 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
94 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at December 31, 2004
|
|
|
24,342 |
|
|
$ |
24 |
|
|
$ |
169,400 |
|
|
$ |
(151,998 |
) |
|
$ |
|
|
|
$ |
|
|
|
$ |
|
|
|
$ |
|
|
|
$ |
17,426 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
F-4
ENDOCARE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY
(DEFICIENCY) (Continued)
(In thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accumulated |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other |
|
|
|
|
|
|
|
|
Common Stock | |
|
|
|
|
|
|
|
Comprehensive |
|
|
|
|
|
Total | |
|
|
| |
|
Additional | |
|
Accumulated | |
|
Receivable From |
|
Income, Net |
|
Deferred |
|
|
|
Stockholders | |
|
|
Shares | |
|
Amount | |
|
Paid-In Capital | |
|
Deficit | |
|
Stockholder |
|
of Tax |
|
Compensation |
|
Treasury Stock |
|
Equity | |
|
|
| |
|
| |
|
| |
|
| |
|
|
|
|
|
|
|
|
|
| |
Net loss
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(13,679 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(13,679 |
) |
Stock options exercised
|
|
|
112 |
|
|
|
|
|
|
|
116 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
116 |
|
Compensation expense
|
|
|
|
|
|
|
|
|
|
|
51 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
51 |
|
Sale of common stock
|
|
|
5,635 |
|
|
|
6 |
|
|
|
8,910 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
8,916 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at December 31, 2005
|
|
|
30,089 |
|
|
$ |
30 |
|
|
$ |
178,477 |
|
|
$ |
(165,677 |
) |
|
$ |
|
|
|
$ |
|
|
|
$ |
|
|
|
$ |
|
|
|
$ |
12,830 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The accompanying notes are an integral part of these
Consolidated Financial Statements.
F-5
ENDOCARE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Years Ended December 31, | |
|
|
| |
|
|
2003 | |
|
2004 | |
|
2005 | |
|
|
| |
|
| |
|
| |
|
|
(In thousands) | |
Cash flows from operating activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss
|
|
$ |
(25,448 |
) |
|
$ |
(37,619 |
) |
|
$ |
(13,679 |
) |
|
Adjustments to reconcile net loss to net cash used in operating
activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation and amortization
|
|
|
4,669 |
|
|
|
3,481 |
|
|
|
3,054 |
|
|
|
Gain on sale of marketable securities
|
|
|
(12 |
) |
|
|
|
|
|
|
|
|
|
|
(Gain) loss on divestitures, net
|
|
|
(8,631 |
) |
|
|
711 |
|
|
|
(609 |
) |
|
|
Compensation expense related to issuance of options, warrants
and restricted stock
|
|
|
1,942 |
|
|
|
136 |
|
|
|
51 |
|
|
|
Treasury stock received as repayment of loan previously forgiven
|
|
|
(21 |
) |
|
|
|
|
|
|
|
|
|
|
Goodwill impairment and other charges
|
|
|
|
|
|
|
15,810 |
|
|
|
26 |
|
|
|
Loss on disposal of fixed assets
|
|
|
|
|
|
|
139 |
|
|
|
107 |
|
|
|
Minority interests
|
|
|
619 |
|
|
|
584 |
|
|
|
(214 |
) |
|
|
Interest expense on common stock warrants
|
|
|
|
|
|
|
|
|
|
|
(657 |
) |
Changes in operating assets and liabilities, net of effects from
purchases and divestitures:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accounts receivable
|
|
|
932 |
|
|
|
(248 |
) |
|
|
(354 |
) |
|
|
Inventories
|
|
|
644 |
|
|
|
(1,516 |
) |
|
|
(318 |
) |
|
|
Prepaid expenses and other current assets
|
|
|
(1,292 |
) |
|
|
1,132 |
|
|
|
(454 |
) |
|
|
Accounts payable
|
|
|
104 |
|
|
|
(394 |
) |
|
|
644 |
|
|
|
Accrued compensation
|
|
|
1,042 |
|
|
|
(150 |
) |
|
|
247 |
|
|
|
Other accrued liabilities
|
|
|
1,615 |
|
|
|
846 |
|
|
|
(2,562 |
) |
|
|
|
|
|
|
|
|
|
|
Net cash used in operating activities
|
|
|
(23,623 |
) |
|
|
(17,088 |
) |
|
|
(14,718 |
) |
|
|
|
|
|
|
|
|
|
|
Cash flows from investing activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Purchases of property and equipment
|
|
|
(276 |
) |
|
|
(456 |
) |
|
|
(423 |
) |
|
Purchases of intangibles
|
|
|
(29 |
) |
|
|
|
|
|
|
(330 |
) |
|
Partnership distributions to minority interests
|
|
|
(709 |
) |
|
|
(739 |
) |
|
|
|
|
|
Sale of available-for-sale securities
|
|
|
22,183 |
|
|
|
|
|
|
|
|
|
|
Proceeds from divestitures
|
|
|
9,480 |
|
|
|
2,388 |
|
|
|
850 |
|
|
Other assets
|
|
|
(1,250 |
) |
|
|
315 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash provided by investing activities
|
|
|
29,399 |
|
|
|
1,508 |
|
|
|
97 |
|
|
|
|
|
|
|
|
|
|
|
Cash flows from financing activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock options and warrants exercised
|
|
|
23 |
|
|
|
92 |
|
|
|
116 |
|
|
Proceeds from sale of stock and warrants, net
|
|
|
|
|
|
|
|
|
|
|
14,596 |
|
|
Repurchase of treasury stock
|
|
|
|
|
|
|
(504 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash provided by (used in) financing activities
|
|
|
23 |
|
|
|
(412 |
) |
|
|
14,712 |
|
|
|
|
|
|
|
|
|
|
|
Net increase (decrease) in cash and cash equivalents
|
|
|
5,799 |
|
|
|
(15,992 |
) |
|
|
91 |
|
Cash and cash equivalents, beginning of year
|
|
|
18,178 |
|
|
|
23,977 |
|
|
|
7,985 |
|
Less: Cash of discontinued operations
|
|
|
(602 |
) |
|
|
(155 |
) |
|
|
32 |
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents, end of year
|
|
$ |
23,375 |
|
|
$ |
7,830 |
|
|
$ |
8,108 |
|
|
|
|
|
|
|
|
|
|
|
Non cash activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Transfer of inventory to property and equipment for placement at
customer sites
|
|
$ |
505 |
|
|
$ |
951 |
|
|
$ |
532 |
|
Other supplemental information:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest paid
|
|
|
40 |
|
|
|
8 |
|
|
|
36 |
|
|
Income taxes paid
|
|
|
2 |
|
|
|
2 |
|
|
|
22 |
|
The accompanying notes are an integral part of these
Consolidated Financial Statements.
F-6
ENDOCARE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Tabular numbers in thousands, except per share data)
|
|
1. |
Organization and Operations of the Company |
Endocare, Inc. (the Company) is a medical device
company focused on developing, manufacturing and selling
cryosurgical products with the potential to improve the
treatment of cancer and other tumors. The Company 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, the Company became an independent,
publicly-owned corporation upon Medstones distribution of
the Companys stock to the existing stockholders on
January 1, 1996.
Through January 31, 2006, the Company also offered vacuum
therapy systems for non-pharmaceutical treatment of erectile
dysfunction through its wholly-owned subsidiary (Timm Medical),
which was sold to a third party effective February 2006 (see
Note 8). The operating results of Timm Medical are included
in discontinued operations.
|
|
2. |
Recent Operating Results and Liquidity |
Since inception, the Company has incurred losses from operations
and has reported negative cash flows. As of December 31,
2005, the Company had an accumulated deficit of approximately
$165.7 million and cash and cash equivalents of
approximately $8.1 million.
The Company expects to continue to generate losses from
operations for the foreseeable future. These losses are expected
to decline. Sales of cryoablation disposable products and
cryoablation procedure fees, representing 94 percent of
total revenues in 2005 compared to 91.5 percent of total
revenues in 2003, increased 48.2 percent from
$17.9 million in 2003 to $26.6 million in 2005. The
Company continues to incur significant costs associated with
ongoing investigations and other matters related to historical
accounting and financial reporting, including obligations to
indemnify former officers and directors in connection with such
investigations. These costs, primarily legal, audit and
accounting support fees, totaled $3.6 million,
$7.1 million and $14.3 million (net of insurance
reimbursement) for the years ended 2005, 2004 and 2003,
respectively. For the year ended December 31, 2005 and
2004, $1.3 million and $2.3 million of these costs
also related to the Companys efforts to achieve compliance
with section 404 of the Sarbanes-Oxley Act of 2002
(Sarbanes 404). The Company also faces large cash
expenditures in the future related to delinquent state and local
tax obligations.
On March 11, 2005, the Company issued 5,635,378 shares
of 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 an aggregate cash
purchase price of $15.6 million ($2.77 per share) in a
private placement to a syndicate of institutional investors as
well as the Companys Chief Executive Officer, President
and Chief Operating Officer and a non-employee director. See
Note 7.
The Company intends to continue investing in its sales and
marketing efforts to physicians in order to raise awareness and
acceptance of the Companys technology. Such investment is
required in order to increase the physicians usage of the
Companys technology in the treatment of prostate and renal
cancers, lung and liver cancers and in the management of pain
from bone metastases. The Company will use existing cash
reserves, the net proceeds from the $15.6 million private
placement of common stock described above and the
$7.5 million net cash proceeds from the sale of Timm
Medical (see Note 8) to finance its projected operating and
cash flow needs along with continued expense management efforts.
The $4 million credit facility (see Note 14) will also
provide short-term funds for working capital needs. Although the
Company expects the aforementioned reserves and sources of
capital are sufficient to fund operations until the Company can
achieve cash flow break even operations, in order to continue as
a going concern, the Company may need to reduce expenses, defer
or eliminate lower priority research and clinical activities,
and/or raise additional capital to
F-7
ENDOCARE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
fund operations through the sale of equity securities to public
or private investors, debt, or the sale or licensing of its
assets. Additional capital may not be available on terms
acceptable to the Company, or at all. If additional capital were
raised through the issuance of equity securities, the percentage
of the Companys stock owned by its then-current
stockholders would be reduced.
|
|
3. |
Summary of Significant Accounting Policies |
|
|
|
Principles of Consolidation |
The consolidated financial statements include the accounts of
the parent and all majority owned and controlled subsidiaries.
All significant intercompany balances and transactions have been
eliminated in consolidation.
The preparation of consolidated financial statements in
conformity with U.S. generally accepted accounting
principles requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities as of the date
of the financial statements. Estimates also affect the reported
amounts of revenues and expenses during the reporting period.
Actual results could differ from these estimates. Principal
areas requiring the use of estimates include: determination of
allowances for uncollectible accounts and sales returns,
warranty obligations, reserves for excess and obsolete
inventory, valuation allowances for investments and deferred tax
assets, impairment of long-lived and intangible assets,
determination of stock-based compensation to employees and
consultants, valuation of the warrants and reserves for
litigation and other legal and regulatory matters, among others.
Revenues from sales of Cryocare Surgical Systems and
cryoablation disposable products are recognized when persuasive
evidence of an arrangement exists, delivery has occurred, the
fee is fixed and determinable, and collectibility is reasonably
assured. The Company also contracts with medical facilities to
provide cryoablation disposable products and services for which
the Company charges 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 and include the necessary disposable
products and supplies. The medical facilities are billed for
procedures performed using Cryocare Surgical Systems owned
either by the Company or by third parties who perform the
service component of the procedure. The Company receives
procedure fee revenue from the medical facility and, where a
third-party service provider is involved, pays a fee to the
service provider. The fee billed to the medical facility is
recorded as revenue in the period when the procedure is
performed. Cost of revenues includes the cost of the procedure
kit and, if applicable, third party service provider fees are
recorded at the time of the procedure. Cost of revenues also
includes depreciation related to Company-owned Cryocare Surgical
Systems over an estimated useful life of three years.
F-8
ENDOCARE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
Revenues and the related cost of revenues from continuing
operations consist of the following for the three years ended
December 31, 2005:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31, | |
|
|
| |
|
|
2003 | |
|
2004 | |
|
2005 | |
|
|
| |
|
| |
|
| |
Revenues:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Product sales:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cryoablation disposable products
|
|
$ |
3,552 |
|
|
$ |
4,584 |
|
|
$ |
6,790 |
|
|
|
Cryocare surgical systems
|
|
|
1,283 |
|
|
|
1,403 |
|
|
|
743 |
|
|
|
Cardiac products (CryoCath)
|
|
|
331 |
|
|
|
|
|
|
|
|
|
|
|
Other (Urohealth)
|
|
|
60 |
|
|
|
49 |
|
|
|
72 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
5,226 |
|
|
|
6,036 |
|
|
|
7,605 |
|
|
Cryoablation procedure fees
|
|
|
14,378 |
|
|
|
17,516 |
|
|
|
19,780 |
|
|
Cardiac royalties (CryoCath)
|
|
|
|
|
|
|
629 |
|
|
|
889 |
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
19,604 |
|
|
$ |
24,181 |
|
|
$ |
28,274 |
|
|
|
|
|
|
|
|
|
|
|
Cost of revenues:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cryoablation disposable products and procedure fees
|
|
$ |
10,626 |
|
|
$ |
13,330 |
|
|
$ |
15,278 |
|
|
Cryocare surgical systems
|
|
|
466 |
|
|
|
255 |
|
|
|
460 |
|
|
Cardiac products (CryoCath)
|
|
|
399 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
11,491 |
|
|
$ |
13,585 |
|
|
$ |
15,738 |
|
|
|
|
|
|
|
|
|
|
|
Cost of revenues for cryoablation disposable products and
procedure fees are combined for reporting purposes. Sales of
cryoablation disposable products and procedure fees incorporate
similar inventory when sold and the Company does not separately
track the cost of disposable products sold directly to customers
and those consumed in cryoablation procedures. Procedure fees
relate to services which are provided to medical facilities upon
request to facilitate the overall delivery of the Companys
technology into the marketplace.
The Company provides customary sales incentives to customers and
distributors in the ordinary course of business. These
arrangements include volume discounts, equipment upgrades,
rent-to-own programs
and minimum revenue guarantees. These transactions are not
significant and are accounted for in accordance with Emerging
Issues Task Force (EITF) Issue
No. 00-21,
Revenue Arrangements with Multiple Deliverables. The
Company defers the recognition of certain Cryocare Surgical
System revenues where it has granted future minimum procedure
fee guarantees or where it has continuing performance
obligations. Deferred revenues are adjusted in future periods
when the minimum procedure fee guarantees or remaining
obligations have been met. Deferred revenue as of
December 31, 2003, 2004, and 2005, totaled
$0.4 million, $0.1 million and $0.1 million,
respectively (included in other accrued liabilities). The
Company settled all minimum guarantee obligations during 2004.
No individual customer accounted for more than 10 percent
of total revenues in 2003, 2004 and 2005. The Company derived
92.8 percent, 91.9 percent and 93.1 percent of
revenues from sales in the United States during this three-year
period.
The Company routinely assesses the financial strength of its
customers and believes that its accounts receivable credit risk
exposure is limited. Accounts receivable are carried at original
invoice amount less an estimate for doubtful accounts and sales
returns based on a periodic review of outstanding receivables.
International shipments are billed and collected by the Company
in U.S. dollars. Allowances are provided for known and
anticipated credit losses as determined by management in the
course of regularly evaluating individual customer receivables.
This evaluation takes into consideration a customers
financial condition and
F-9
ENDOCARE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
credit history as well as current economic conditions. Accounts
receivable are written off when deemed uncollectible. Recoveries
of accounts receivable previously written off are recorded when
received.
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. The
Company evaluates the adequacy of these reserves periodically.
The following is a summary of inventory (excluding assets of
discontinued operations):
|
|
|
|
|
|
|
|
|
|
|
|
December 31, | |
|
|
| |
|
|
2004 | |
|
2005 | |
|
|
| |
|
| |
|
|
(In thousands) | |
Raw materials
|
|
$ |
1,727 |
|
|
$ |
1,646 |
|
Work in process
|
|
|
443 |
|
|
|
275 |
|
Finished goods
|
|
|
1,036 |
|
|
|
911 |
|
|
|
|
|
|
|
|
|
Total inventories
|
|
|
3,206 |
|
|
|
2,832 |
|
Less inventory reserve
|
|
|
(378 |
) |
|
|
(370 |
) |
|
|
|
|
|
|
|
|
Inventories, net
|
|
$ |
2,828 |
|
|
$ |
2,462 |
|
|
|
|
|
|
|
|
Property and equipment are stated at cost and are depreciated on
a straight-line basis over the estimated useful lives of the
respective assets, which range from three to seven years.
Leasehold improvements are amortized over the shorter of the
estimated useful lives of the assets or the related lease term.
Cryosurgical equipment placed at customer sites for use with the
Companys disposable cryoprobes is depreciated into cost of
revenues over estimated useful lives of three years. Repair and
maintenance costs are expensed as incurred. Depreciation expense
from continuing operations was $2.4 million,
$2.0 million and $1.7 million in 2003, 2004 and 2005,
respectively.
The following is a summary of property and equipment (excluding
assets of discontinued operations):
|
|
|
|
|
|
|
|
|
|
|
|
December 31, | |
|
|
| |
|
|
2004 | |
|
2005 | |
|
|
| |
|
| |
|
|
(In thousands) | |
Equipment and computers
|
|
$ |
1,504 |
|
|
$ |
1,697 |
|
Cryosurgical systems placed at customer sites
|
|
|
5,778 |
|
|
|
5,746 |
|
Furniture and fixtures
|
|
|
834 |
|
|
|
905 |
|
Leasehold improvements
|
|
|
321 |
|
|
|
321 |
|
|
|
|
|
|
|
|
|
Total property and equipment, at cost
|
|
|
8,437 |
|
|
|
8,669 |
|
Accumulated depreciation and amortization
|
|
|
(5,765 |
) |
|
|
(6,875 |
) |
|
|
|
|
|
|
|
|
Property and equipment, net
|
|
$ |
2,672 |
|
|
$ |
1,794 |
|
|
|
|
|
|
|
|
|
|
|
Long-Lived Assets, Goodwill and Intangible Assets Subject to
Amortization |
The Company acquires goodwill and amortizable intangible assets
in business combinations and asset purchases. The excess of the
purchase price over the fair value of net assets acquired are
allocated to goodwill and identifiable intangibles. The Company
does not amortize goodwill which is consistent with the
provisions
F-10
ENDOCARE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
of Statement of Financial Accounting Standards
(SFAS) No. 142, Goodwill and other Intangible
Assets as more fully described in Note 6. Goodwill and
indefinite lived assets are reviewed annually for impairment and
on an interim basis if events or changes in circumstances
indicate that the asset might be impaired.
Intangible assets that are deemed to have finite useful lives
are recorded at cost and amortized using the straight-line
method over their estimated useful lives, as follows:
|
|
|
|
|
Trade names (discontinued operations)
|
|
|
15 years |
|
Domain names
|
|
|
5 years |
|
Covenants not to compete
|
|
|
3 to 5 years |
|
Developed technology (discontinued operations)
|
|
|
15 years |
|
Patents
|
|
|
3 to 15 years |
|
In accordance with SFAS No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets, the Company
reviews long-lived assets for impairment whenever events or
changes in circumstances indicate that the carrying value of
such assets may not be recoverable. The Company considers assets
to be impaired and write them down to fair value if estimated
undiscounted cash flows associated with those assets are less
than their carrying amounts. Fair value is based upon the
present value of the associated cash flows. Changes in
circumstances (for example, changes in laws or regulations,
technological advances or changes in the Companys
strategies) may also reduce the useful lives from initial
estimates. Changes in the planned use of intangibles may result
from changes in customer base, contractual agreements, or
regulatory requirements. In such circumstances, the Company will
revise the useful life of the long-lived asset and amortize the
remaining net book value over the adjusted remaining useful
life. There were no changes in estimated useful lives during
2003, 2004 and 2005. In the third quarter of 2004, the Company
recorded a $9.9 million impairment charge relating to the
mobile prostate treatment partnerships (included in continuing
operations) and an impairment charge of $5.9 million
related to Timm Medical (included in discontinued operations)
(see Notes 6 and 8). No impairment charge was recorded in
2003 or 2005.
Amortization expense for each of the years ending
December 31 will consist of the following amounts
(excluding discontinued operations):
|
|
|
|
|
2006
|
|
$ |
537 |
|
2007
|
|
|
467 |
|
2008
|
|
|
467 |
|
2009
|
|
|
467 |
|
2010
|
|
|
467 |
|
Thereafter
|
|
|
1,762 |
|
|
|
|
|
|
|
$ |
4,167 |
|
|
|
|
|
Amortization expense from continuing operations totaled
$0.6 million, $0.7 million and $0.6 million in
2003, 2004 and 2005, respectively.
F-11
ENDOCARE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
The following is a summary of intangible assets (excluding
discontinued operations):
|
|
|
|
|
|
|
|
|
|
|
|
December 31, | |
|
|
| |
|
|
2004 | |
|
2005 | |
|
|
| |
|
| |
|
|
(In thousands) | |
Domain name
|
|
$ |
435 |
|
|
$ |
435 |
|
Covenant not to compete
|
|
|
352 |
|
|
|
352 |
|
Patents
|
|
|
5,875 |
|
|
|
6,205 |
|
|
|
|
|
|
|
|
|
Total intangibles
|
|
|
6,662 |
|
|
|
6,992 |
|
Accumulated amortization
|
|
|
(2,272 |
) |
|
|
(2,825 |
) |
|
|
|
|
|
|
|
|
Intangibles, net
|
|
$ |
4,390 |
|
|
$ |
4,167 |
|
|
|
|
|
|
|
|
During 2003, the Company invested in a diversified portfolio of
marketable debt securities, including corporate bonds,
government agency securities and commercial papers. These
securities were sold in 2003 for an insignificant gain. The
Company also holds other investments which primarily consist of
strategic investments of less than 20 percent equity
interest in certain companies acquired in conjunction with
various strategic alliances. These represent minority interests
in start-up technology
companies. The Company does not have the ability to exercise
significant influence over the financial or operational policies
or administration of any of these companies; therefore, they are
accounted for under the cost method. Realized gains and losses
are recorded when related investments are sold. Investments in
privately-held companies are regularly assessed for impairment
through review of operations and indicators of continued
viability, including operating performance, financing status,
liquidity prospects and cash flow forecasts. Impairment losses
are recorded when events and circumstances indicate that such
assets might be impaired and the decline in value is
other-than-temporary. These investments are included in
investments and other assets.
Certain of the Companys products are covered by warranties
against defects in material and workmanship for periods up to
two years after the sale date. The estimated warranty cost is
recorded at the time of sale and is adjusted periodically to
reflect actual experience. Factors that affect the
Companys warranty liability include the number of units
sold, historical and anticipated rates of warranty claims, and
cost per claim. The Companys warranty costs and liability
(included in other accrued liabilities) were not significant.
Research and development expenditures primarily include
personnel, clinical studies, and material expenses incurred to
design, create, and test prototypes. These expenditures are
charged to operations as incurred until technological
feasibility has been established.
Amounts incurred for advertising costs are included in selling
and marketing expenses as incurred and totaled
$0.3 million, $0.5 million and $0.3 million for
2003, 2004 and 2005, respectively.
|
|
|
Cash and Cash Equivalents |
All highly liquid investments purchased with an original
maturity of three months or less are considered to be cash
equivalents. Cash and cash equivalents include money market
funds and various deposit accounts.
F-12
ENDOCARE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
|
|
|
Concentrations of Credit Risk |
Financial instruments, which potentially subject the Company to
concentrations of credit risk, primarily consist of cash and
cash equivalents, and accounts receivable. The Company from time
to time may be exposed to credit risk with its bank deposits in
excess of the FDIC insurance limits. The Company has not
experienced any losses in such accounts and believes it is not
exposed to any significant credit risk on cash and cash
equivalents. The Companys receivables are derived
primarily from sales of Cryocare Surgical Systems and
cryoablation disposable products to medical facilities, medical
groups and urologists. Cryoablation procedure fees are generated
from medical facilities. The Company has a diversified customer
base and no single payor is considered a high credit risk. The
Company performs ongoing credit evaluations of its customers and
generally does not require collateral. Reserves are maintained
for potential credit losses.
|
|
|
Fair Value of Financial Instruments |
The primary objective of the Companys investment
activities is to preserve principal while at the same time
maximize the income the Company receives from its invested cash
without significantly increasing the risk of loss. The
Companys consolidated balance sheets include the following
financial instruments: cash and cash equivalents, accounts
receivable, minority investments, accounts payable, accrued
liabilities and common stock warrants. The carrying amounts of
current assets and liabilities approximate their fair values
because of the relatively short period of time between the
origination of these instruments and their expected realization.
The common stock warrants are recorded at fair value, which is
adjusted each quarter using a modified
Black-Scholes pricing
model.
The Companys profitability depends in large part on
increasing its revenue base and effectively managing costs of
sales, customer acquisition costs and administrative overhead.
The Company continually reviews its pricing and cost structure
in an effort to select the optimal revenue and distribution
models. Several factors could adversely affect revenues and
costs, such as changes in health care practices, payor
reimbursement, inflation, new technologies, competition and
product liability litigation, which are beyond the
Companys control and could adversely affect the
Companys ability to accurately predict revenues and
effectively control costs. Many purchasers of the Companys
products and services rely upon reimbursement from third-party
payors, including Medicare, Medicaid and other government or
private organizations. These factors could have a material
adverse effect on the Companys financial condition,
results of operations or cash flows.
Certain previously reported amounts have been reclassified to
conform with the current presentation.
|
|
|
Off-Balance Sheet Financings and Liabilities |
Other than lease commitments, legal contingencies incurred in
the normal course of business, and employment contracts, the
Company does not have any off-balance sheet financing
arrangements or liabilities. In addition, the Companys
policy is not to enter into derivative instruments, futures or
forward contracts. The Companys business is transacted
solely in U.S. dollars and, while future fluctuations of
the U.S. dollar may affect the price competitiveness of the
Companys products, there is no known significant direct
foreign currency exchange rate risk. Finally, the Company does
not have any majority-owned subsidiaries or any interests in, or
relationships with, any material special-purpose entities that
are not included in the consolidated financial statements.
F-13
ENDOCARE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
|
|
|
Other Accrued Liabilities |
Other accrued liabilities as of December 31, 2004 and 2005
includes $3.3 million and $3.4 million in state and
local taxes, primarily sales and use taxes in various
jurisdictions in the United States. Also included in other
accrued liabilities is accrued professional fees which total
$2.7 million and $1.7 million as of December 31,
2004 and 2005, respectively.
|
|
|
Capital Stock and Earnings Per Share |
During the first quarter of 2004, the Company retired 326,222 of
its common shares held in treasury, including
120,022 shares purchased from BioLife Solutions, Inc.
(BioLife) for approximately $0.5 million in
February 2004, in connection with settlement of its litigation
with BioLife (See Note 13 Commitments and
Contingencies Legal Matters).
Basic net income or loss per share is computed by dividing net
income or 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 the Company
reported a net loss from continuing operations, these
potentially dilutive common shares were excluded from the
diluted income or loss per share calculation because they were
antidilutive.
The Company recognizes deferred tax assets and liabilities for
temporary differences between the financial reporting basis and
the tax basis of the Companys assets and liabilities along
with net operating loss and credit carryforwards, if it is more
likely than not that the tax benefits will be realized. To the
extent a deferred tax asset cannot be recognized under the
preceding criteria, allowances must be established. The impact
on deferred taxes of changes in tax rates and laws, if any, are
applied to the years during which temporary differences are
expected to be settled and reflected in the financial statements
in the period of enactment.
As of December 31, 2005, the Company had four stock-based
compensation plans, including the 2004 Stock Incentive Plan
approved by the Companys shareholders on
September 10, 2004. The Company accounts for the plans
under the recognition and measurement principles (the
intrinsic-value method) prescribed in Accounting Principles
Board (APB) Opinion No. 25, Accounting for Stock
Issued to Employees, and related interpretations.
Compensation expense for stock options granted to employees is
reflected in net loss and is measured as the excess of the
market price of the Companys stock at the date of grant
over the exercise price. Compensation expense for fixed awards
that are subject to vesting are recognized over the vesting
period. In practice, the Company has only awarded stock options
to its employees with exercise prices equal to the fair market
value of the stock at the date of grant.
F-14
ENDOCARE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
The Company has adopted the disclosure provisions required by
SFAS No. 148, Accounting for Stock-Based
Compensation Translation and Disclosure. The
following table illustrates the effect on net loss and loss per
share if the Company had applied the fair value recognition
provisions to stock-based employee compensation. The amounts in
the table below include stock-based compensation expense related
to Timm Medical which was not significant.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31, | |
|
|
| |
|
|
2003 | |
|
2004 | |
|
2005 | |
|
|
| |
|
| |
|
| |
|
|
(In thousands) | |
Net loss, as reported(a)(c)
|
|
$ |
(25,448 |
) |
|
$ |
(37,619 |
) |
|
$ |
(13,679 |
) |
Reconciling items:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Add: Stock-based employee compensation expense determined under
the intrinsic-value-based method for all awards(b)
|
|
|
25 |
|
|
|
136 |
|
|
|
43 |
|
|
Less: Stock-based compensation expense determined under the
fair-value-based method for all awards expense(c)
|
|
|
(2,313 |
) |
|
|
(3,875 |
) |
|
|
(3,696 |
) |
|
|
|
|
|
|
|
|
|
|
Net adjustment
|
|
|
(2,288 |
) |
|
|
(3,739 |
) |
|
|
(3,653 |
) |
|
|
|
|
|
|
|
|
|
|
Net loss, as adjusted
|
|
$ |
(27,736 |
) |
|
$ |
(41,358 |
) |
|
$ |
(17,332 |
) |
|
|
|
|
|
|
|
|
|
|
Basic and diluted loss per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As reported
|
|
$ |
(1.05 |
) |
|
$ |
(1.55 |
) |
|
$ |
(0.47 |
) |
|
As adjusted
|
|
$ |
(1.15 |
) |
|
$ |
(1.70 |
) |
|
$ |
(0.60 |
) |
The fair value of each option grant is estimated on the date of
grant using the Black-Scholes option pricing model, with the
following assumptions:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2003 | |
|
2004 | |
|
2005 | |
|
|
| |
|
| |
|
| |
Stock volatility
|
|
|
1.57 |
|
|
|
0.89 |
|
|
|
0.90 |
|
Risk-free interest rate
|
|
|
3.4 |
% |
|
|
3.6 |
% |
|
|
4.0 |
% |
Expected life in years
|
|
|
5 years |
|
|
|
5 years |
|
|
|
5 years |
|
Stock dividend yield
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(a) |
|
In the past, the Company had issued stock options and warrants
to consultants for services performed. Compensation expense for
the fair value of these options was determined by the
Black-Scholes option-pricing model and was charged to operations
over the service period or as performance goals were achieved.
Such expense was included in net loss as reported. |
|
(b) |
|
Since the Company issues options with exercise prices equal to
or exceeding the fair values of the underlying common stock, no
compensation expense is recorded for options issued to
employees. The recorded expense generally relates to
compensation charges upon modification of vesting terms,
cashless exercises, and other non-routine transactions. |
|
(c) |
|
Pursuant to APB No. 25, the reported net loss for 2003
included $1.8 million in compensation expense relating to
option settlements with two former executives in conjunction
with their separation agreements (including a $1.7 million
charge for replacement options recorded upon termination of the
former CFO/COO on July 31, 2003). Pursuant to SFAS Nos. 123
and 148, the fair value of the replacement options would have
been recorded between the option modification date of
March 3, 2003 and termination date. The $2.3 million
expense for 2003 represents stock-based compensation determined
under SFAS Nos. 123 and 148, less the $1.8 million
recorded charge. |
F-15
ENDOCARE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
|
|
5. |
New Accounting Pronouncements |
In December 2004, SFAS No. 123R, Share-Based
Payment, was issued. SFAS No. 123R is a revision
of SFAS No. 123, Accounting for Stock Based
Compensation, and supersedes APB No. 25. Among other
items, SFAS 123R eliminates the use of APB No. 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. The
effective date of SFAS 123R is the first quarter 2006 for
calendar year companies. 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, modified or settled after that date, and based on the
requirements of SFAS 123 for all unvested awards granted
prior to the effective date. 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 pro forma disclosures made in accordance with
SFAS 123. The Company will adopt the modified prospective
method.
The Company currently utilizes 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
this model, the standard also permits the use of a
lattice model. Upon adoption the Company will
continue to use the Black-Scholes standard option pricing 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, the Company
has not recognized the benefits for excess tax deductions in our
operating cash flows in prior periods due to the uncertainty of
when the Company will generate taxable income to realize such
benefits. The adoption of SFAS No. 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 No. 123R cannot be predicted at this time because
it will depend on levels of share-based payments granted in the
future. However, had the Company adopted SFAS No. 123R
in prior periods, the impact of that standard would have
approximated the pro forma net loss and loss per share disclosed
in the table above. See Note 10 for further information on
our stock-based compensation plans.
In November 2004, SFAS 151, Inventory Costs
an amendment of ARB No. 43, Chapter 4, was issued.
This Statement amends the guidance in Accounting Research
Bulletin (ARB) No. 43, Chapter 4, Inventory
Pricing, to clarify the accounting for abnormal amounts of
idle facility expense, freight, handling costs, and wasted
material (spoilage). SFAS No. 151 is effective for
inventory costs incurred during fiscal years beginning after
June 15, 2005. The Company does not expect adoption of this
standard to have a material impact on its consolidated financial
statements.
In May 2005, SFAS No. 154, Accounting Changes and
Error Corrections, which replaced APB No. 20,
Accounting Changes, and SFAS No. 3,
Reporting Changes in Interim Financial Statements, was
issued. 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
F-16
ENDOCARE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
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 the Companys
consolidated financial position or results of operations.
Under SFAS No. 142, Goodwill and Other Intangible
Assets, goodwill and indefinite-lived intangible assets are
not amortized but instead are reviewed annually for impairment
and on an interim basis if events or changes in circumstances
between annual tests indicate that an asset might be impaired.
Goodwill is tested for impairment by comparing its fair value to
its carrying value under a two-step process. The first step
requires the Company to compare the fair value of its reporting
units to the carrying value of the net assets of the respective
reporting units, including goodwill. The Companys
management is primarily responsible for estimating fair value
for impairment purposes. Management may consider a number of
factors, including valuations or appraisals, when estimating
fair value. If the fair value of the reporting unit is less than
the carrying value, goodwill of the reporting unit is
potentially impaired and the Company then completes step two to
measure the impairment loss, if any. The second step requires
the calculation of the implied fair value of goodwill by
deducting the fair value of all tangible and intangible net
assets of the reporting unit from the fair value of the
reporting unit. If the implied fair value of goodwill is less
then the carrying amount of goodwill, an impairment loss is
recognized equaled to the difference.
In accordance with SFAS No. 142, the Company completed
its annual goodwill impairment test on October 1 of each
year for all of its reporting units. The Company assessed the
fair values of each reporting unit based on a weighted
combination of (i) the guideline company method that
utilizes revenue multiples for comparable publicly-traded
companies, and (ii) a discounted cash flow model that
utilizes future net cash flows, the timing of these cash flows,
and a discount rate (or weighted average cost of capital which
considers the cost of equity and cost of debt financing expected
by a typical market participant) representing the time value of
money and the inherent risk and uncertainty of the future cash
flows. The Company then determined the implied fair
value of the goodwill and amortizable intangibles. Based
on this analysis, the Company recorded:
|
|
|
a) A third quarter of 2004 impairment charge of
$5.9 million to reduce the carrying value of Timm
Medicals goodwill ($3.1 million) and developed
technology ($2.1 million) to fair value and an additional
charge of approximately $0.7 million for the estimated cost
to sell Timm Medical. The charge is included in the net loss
from discontinued operations. The interim impairment analysis in
the third quarter of 2004 was required based on the
Companys decision to actively market Timm Medical to
potential buyers in July 2004, as well as declining revenues,
turnover in sales force, and below average growth as compared to
general industry trends. Based on the purchase price received by
the Company from the sale of Timm Medical completed in February
2006 (see Note 8), there was no further impairment as of
December 31, 2005. |
|
|
b) A third quarter of 2004 impairment charge of
$9.9 million to write-off the carrying value of goodwill
($9.8 million) and covenant not to compete
($0.1 million) with respect to the pending divestiture of
the mobile prostate treatment businesses (the Partnerships). We
originally acquired the Partnerships in September 2002. The
goodwill primarily related to the distribution network provided
by the Partnerships, which allowed the Company to further
penetrate desired markets. Since investors in the mobile
treatment businesses are comprised of urologists, the
Partnerships facilitated the continued promotion of cryosurgery
as the preferred treatment for prostate cancer. In addition,
upon the Companys purchase of the Partnerships, the seller
(USMD) exited the cryosurgical operations and terminated
its exclusive distribution agreement with the Company, allowing
the Company to access a previously restricted market. After the
Company sold the Partnerships in December 2004, the Company
still expected to, and did, retain access to the service and
distribution network through the Companys existing |
F-17
ENDOCARE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
|
|
|
contracts and continue to benefit from the strategic value of a
non-exclusive distribution arrangement with the buyer. However,
since this economic benefit could not be quantified with
reasonable accuracy, the Company recorded the $9.9 million
charge to write off the excess of the carrying value of the
Partnerships net assets over the preliminary purchase
offer, less selling costs. See Note 8 for the loss recorded
upon final sale in the fourth quarter of 2004. |
|
|
7. |
Private Placement of Common Stock and Warrants |
On March 11, 2005, the Company 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 the
Company at a price of $0.01 per share underlying such
warrant if the Companys 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) the Company provides
30-day advanced written
notice (Notice Period), (b) the Company simultaneously
calls 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, the Company will pay transaction fees equal to
six percent of the warrant proceeds under an existing
capital advisory agreement.
Pursuant to the terms of the registration rights agreement, the
Company 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, the Company will be required to pay each holder an amount
in cash, as liquidated damages, equal to one percent per month
of the aggregate purchase price paid by such holder. The Company
incurred liquidated damages through September 28, 2005,
when the
S-2 registration
statement was declared effective. For the year ended
December 31, 2005, the Company incurred $0.6 million
of liquidated damages which are included in general and
administrative expenses.
Since the liquidated damages under the registration rights
agreement could in some cases exceed a reasonable discount for
delivering unregistered shares, the warrants have been
classified as a liability until the earlier of the date the
warrants are exercised in full or expire. In accordance with
EITF 00-19,
Accounting for Derivative Financial Instruments Indexed To,
and Potentially Settled In, a Companys Own Stock, the
Company has allocated a portion of the offering proceeds to the
warrants based on their fair value.
EITF 00-19 also
requires that the Company 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. The
Company determined the fair value of the warrants as follows as
of December 31, 2005:
|
|
|
|
|
First, the Black-Scholes option-pricing model was used with the
following assumptions: an expected life equal to the remaining
contractual term of the warrants (4.25 years); no
dividends; a risk free rate |
F-18
ENDOCARE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
|
|
|
|
|
of 4.35 percent, which equals the yield on Treasury bonds
at constant (or fixed) maturity equal to the remaining
contractual term of the warrants; and volatility of
89.46 percent. Under these assumptions, the Black-Scholes
option-pricing model yielded a value of $1.73 for each of the
Series A warrants and $1.67 for each of the Series B
warrants, for an aggregate value of $6.7 million; |
|
|
|
Second, since the warrants are limited in the amount of
realizable profit to the holders as a result of the call
provision described above, the Company 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 the Company has the right to call the
Series A and Series B warrants, effectively compelling
the holders to exercise their warrants). The Company used a
statistical formula to calculate the probability that the
Companys stock price will reach or exceed $6.50 and $7.50,
respectively. Based on this formula, the Company calculated
that, for the Series A warrants, the probability that the
stock price of $6.50 will be reached or exceeded is
approximately 22.8 percent. Similarly, the Company
calculated that, for the Series B warrants, the probability
that the stock price of $7.50 will be reached or exceeded is
approximately 17.3 percent. Based on these probabilities,
the Company reduced the valuation of each of the Series A
warrants to $1.34 (which equals one minus 22.8 percent,
multiplied by $1.73) and reduced the valuation of each of the
Series B warrants to $1.38 (which equals one minus
17.3 percent, multiplied by $1.67). This yields an
aggregate value of the warrants equal to
$5.4 million; and |
|
|
|
Third, the Company further reduced the value of the warrants on
the assumption that its 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 there
are approximately 30 million shares outstanding, the
Company calculated that the exercise of the warrants will result
in dilution of approximately 6.2 percent. Using the
dilution figure of 6.2 percent, the Company reduced the
value of each of the Series A warrants to $1.25 and the
Series B warrants to $1.29. This yields an aggregate value
of the warrants equal to $5.0 million. |
As a result of this fair value calculation, the Company recorded
negative interest expense of $0.7 million for the year
ended December 31, 2005, which represents the change in the
fair value of the warrants from $5.6 million on
March 11, 2005, the date of issuance. This change was
primarily due to a decrease in the fair value of the underlying
common stock from $3.00 as of March 11, 2005 to $2.74 as of
December 31, 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. The
Company does not expect that the warrants will be exercised
within the next 12 months based on the current trading
prices of our common stock and has classified the warrants as a
non-current liability at December 31, 2005. Changes in fair
value during each period will be recorded as interest expense.
Two members of the Companys management team made personal
investments totaling $0.7 million in the aggregate, and a
member of the board of directors invested $0.3 million.
|
|
|
Other Warrants Issued (expired as of December 31,
2005) |
The Company had issued warrants in conjunction with previous
debt financing transactions, underwriting agreements, patent
licenses and service contracts. Warrants generally have a
contractual term of five years and vest over a one- to five-year
period. The Company had issued warrants to
purchase 25,000 shares of the Companys common
stock at an exercise price of $9.00 per share. These
warrants expired on January 3, 2005, and none were
exercised prior to their expiration.
The Company also issued detachable warrants to investors to
purchase 188,680 shares of the Companys common
stock in conjunction with a November 2000 private placement.
These warrants have a five-year term
F-19
ENDOCARE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
and were immediately exercisable at $13.91 per share. As of
December 31, 2005, all warrants issued were expired.
The Company estimates the fair value of each warrant on the date
of grant using the Black-Scholes option pricing model, with the
assumptions similar to option grants above. Warrants granted in
connection with the issuance of equity and debt and asset
purchase transactions are recorded to additional paid-in
capital. Warrants issued for services are amortized to expense
over the related service periods.
|
|
8. |
Dispositions and Discontinued Operations |
The Company acquired Timm Medical in February 2002. During 2003
certain non-core product lines of Timm Medical were divested
(see below). In July 2004, the Company began to actively market
Timm Medical for sale in conjunction with a fund-raising
initiative. The Company reported Timm Medical as an asset held
for sale and recorded an impairment charge totaling
$5.9 million to reduce the carrying value of Timm Medical
to fair value, less costs to sell. Following the completion of
the $15.6 million private placement in March 2005 (see
Note 7 Private Placement of Common Stock
and Warrants) the Company reclassified Timm Medical as
held and used in the first quarter of 2005 as the Company no
longer was seeking a buyer and had ceased all marketing efforts.
As a result of this change in plan, included in net income from
discontinued operations for the year ended December 31,
2005 is $0.4 million in depreciation and amortization
expense for fixed assets and intangibles for the period from
July 31, 2004 to March 31, 2005 and $0.6 million
income as a result of the elimination of the estimated costs to
sell, which were previously reported as a component of the 2004
impairment charge.
In late 2005 the Company received substantive expression of
interest from Plethora Solutions Holdings plc (Plethora), a
company listed on the London Stock Exchange, to acquire Timm
Medical and the parties entered into a Stock Purchase Agreement
on January 13, 2006. The transaction closed on
February 10, 2006. The Company will not receive significant
direct cash flows from Timm Medical or have significant
continuing involvement in its operations after the sale. In
accordance with SFAS No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets, the assets and
liabilities of Timm Medical were classified as discontinued
operations in the consolidated financial statements for each
year presented. The assets and liabilities of Timm Medical as of
December 31, 2005 have been classified as current. Sale
proceeds (net of $0.6 million of transaction costs) totaled
$8.9 million and will result in a gain on sale of
$0.7 million to be recorded in the first quarter of 2006.
Gross proceeds of $9.5 million includes cash of
$8.1 million and a two-year, five percent promissory note
secured by the assets of Timm Medical. The note is convertible
into Plethoras ordinary shares at any time by the Company.
If Plethoras shares trade above a specified amount for 20
consecutive days, Plethora has the option to require conversion.
The Company agreed to retain certain assets and liabilities of
Timm Medical, including all tax liabilities ($1.1 million),
obligations and rights to a $2.7 million note receivable
from the sale of the urinary incontinence product line (see
below), certain litigation to which Timm Medical is a party and
Urohealth BV (Timm Medicals wholly-owned subsidiary with
insignificant operations). Assets and liabilities retained and
their related revenues and expenses are excluded from
discontinued operations. The Stock Purchase Agreement contains
an indemnification escrow of $1.4 million (proceeds from
the note receivable) to indemnify the buyer against certain
claims and liabilities.
F-20
ENDOCARE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
Assets and liabilities of discontinued operations as of
December 31, include the following:
|
|
|
|
|
|
|
|
|
|
|
2004 | |
|
2005 | |
|
|
| |
|
| |
|
|
(In thousands) | |
Assets:
|
|
|
|
|
|
|
|
|
Cash, inventories and other current assets
|
|
$ |
1,185 |
|
|
$ |
1,216 |
|
Property and equipment, net
|
|
|
467 |
|
|
|
75 |
|
Goodwill, net
|
|
|
4,552 |
|
|
|
4,552 |
|
Intangibles, net
|
|
|
4,170 |
|
|
|
3,716 |
|
Other assets
|
|
|
66 |
|
|
|
65 |
|
|
|
|
|
|
|
|
Total assets
|
|
$ |
10,440 |
|
|
$ |
9,624 |
|
|
|
|
|
|
|
|
|
Liabilities:
|
|
|
|
|
|
|
|
|
Accounts payable and other current liabilities
|
|
$ |
651 |
|
|
$ |
942 |
|
Other accrued liabilities
|
|
|
524 |
|
|
|
519 |
|
Costs to sell
|
|
|
680 |
|
|
|
|
|
|
|
|
|
|
|
|
Total liabilities
|
|
|
1,855 |
|
|
|
1,461 |
|
|
|
|
|
|
|
|
Net assets
|
|
$ |
8,585 |
|
|
$ |
8,163 |
|
|
|
|
|
|
|
|
Revenues for Timm Medical were $11.0 million,
$8.5 million and $9.3 million in 2003, 2004 and 2005,
respectively. The operations of Timm Medical are classified as
discontinued operations as a result of the sale of Timm Medical
in 2006 (See Subsequent Events). The 2004 loss from
Timm Medical included a $5.9 million impairment charge to
write down the goodwill and intangible assets.
|
|
|
Divestitures of Non-Core Product Lines 2003 |
In 2003, the Company embarked on a strategy to refocus the
Companys core technological competence and primary market
emphasis on the development of minimally invasive technologies
for tissue and cancer ablation. Part of this strategy entails
divestiture of certain non core product lines including the
cardiac-related product manufacturing operations and license of
related technology. Included in the 2003 loss from discontinued
operations is a $35,000 gain on the sale of the Dura II
penile implants and a $1.3 million loss on the sale of the
Timm Medical urinary incontinence and urodynamics product lines,
which is further discussed below.
|
|
|
Cryosurgical Products for Cardiac Applications |
On April 14, 2003, the Company sold its cardiac-related
product manufacturing operations and licensed the related
intellectual property to CryoCath Technologies, Inc. (CryoCath)
for $10.0 million. CryoCath was the exclusive distributor
for cryoprobes and consoles in connection with the
SurgiFrosttm
system, a cryoablation system designed to treat cardiac
arrhythmias. The Company transferred all of the Companys
manufacturing assets and inventory related to the cardiac
product line to CryoCath, including technical know-how, vendor
lists, production equipment and inventory. In addition, CryoCath
received an exclusive worldwide perpetual license for cardiac
uses to the Companys proprietary argon gas based
technology associated with the product and will make payments to
the Company under a nine-year descending royalty stream based on
net sales of products incorporating the licensed technology. The
Company also agreed to a
12-year worldwide
covenant not to compete in the cardiac field. Upon the
consummation of the sale, the Company terminated its
pre-existing distribution agreement with CryoCath. The Company
is required to attend quarterly and annual technical update
meetings through 2014. Since the technology was internally
developed and the tangible assets sold had minimal value, the
sale resulted in a 2003 second quarter gain of
$10.0 million. The royalty stream
F-21
ENDOCARE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
decreases from 10 percent to 3 percent of net sales
from the
SurgiFrosttm
system during the period 2004 to 2012. The royalty payments will
be recorded in the periods earned. The Company had collected
$7.5 million of the total sale proceeds in 2003 and the
remaining $2.5 million in January 2004. Royalty income was
$0.6 million and $0.9 in 2004 and 2005, respectively.
|
|
|
Urinary Incontinence and Urodynamics |
On October 15, 2003, Timm Medical agreed to sell the
manufacturing assets related to its urodynamics and urinary
incontinence product lines to SRS Medical Corp.
(SRS) for a $2.7 million note. These assets
include certain patents and trademarks related to the
urodynamics and urinary incontinence products, inventory,
customer lists and technical know-how. The note bears interest
at 7.5 percent and is secured by the assets sold. As
amended in March 2004, the note requires quarterly payments of
$45,000 beginning March 31, 2004, increasing to $60,000 for
the quarter ended December 31, 2005. Amounts which remain
outstanding at December 31, 2005 will be payable at least
$60,000 per quarter until the outstanding principal and
accrued interest are paid in full. The carrying values of the
urodynamics and urinary incontinence related assets were
$1.3 million on the date of sale. Management concluded that
collection of the note from SRS was not reasonably assured. As a
result, a loss of $1.3 million was recorded in the fourth
quarter of 2003 equal to the carrying value of the assets sold
and collections on the note, if any, will be reported as gain in
the period received. Collections during 2004 and 2005 were
$0.2 million and $0.3 million and have been applied to
accrued interest. As of December 31, 2005 the note was
transferred from Timm Medical to Endocare prior to the sale of
Timm Medical.
The combined revenues, costs of revenues and gross profit
related to the divested product lines were $2.0 million,
$1.0 million and $1.0 million, respectively, for 2003,
and $5.4 million, $2.3 million and $3.1 million,
respectively, for 2004 and are included in income (loss) from
discontinued operations.
Incremental selling, general and administrative expenses
attributable to these product lines were not significant.
|
|
|
Mobile Prostate Treatment Businesses (Partnerships) |
On December 30, 2004, the Company entered into a
Partnership Interest Purchase Agreement (the Purchase
Agreement) with Advanced Medical Partners, Inc.
(AMPI), a customer of and third-party service
provider to the Company. Pursuant to the Purchase Agreement, the
Company agreed to sell to AMPI the Companys interests in
nine partnerships and the Companys minority investment in
U.S. Therapies, LLC (a national urology services company)
acquired in June 2001 for $0.9 million. As a result of the
sale, the Company recorded a loss on divestiture of
$0.7 million in the 2004 fourth quarter. The loss comprises
$0.9 million in proceeds less selling costs of
approximately $63,000 and $1.5 million of the net tangible
assets sold. The proceeds were received in February 2005 and
were included in prepaid expenses and other current assets as of
December 31, 2004. After the sale, the Company continues to
pay the Partnerships, similar to other service providers, the
contracted fee for mobile support services. As such, the
Partnerships are not presented as discontinued operations. The
four remaining mobile treatment businesses have ceased
operations or are pending dissolution.
|
|
9. |
Stock-Based Compensation Plans |
As of December 31, 2005, the Company had four stock-based
compensation plans. On September 10, 2004, the
Companys stockholders approved the 2004 Stock Incentive
Plan. The Company accounts for the plans under the recognition
and measurement principles (the intrinsic-value method)
prescribed in APB No. 25, Accounting for Stock Issued to
Employees, and related interpretations. Compensation cost
for stock options granted to employees is reflected in net loss
and is measured as the excess of the market price of the
Companys stock at the date of grant over the exercise
price. Compensation costs for fixed awards that are
F-22
ENDOCARE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
subject to vesting are recognized pro rata over the vesting
period. In practice, the Company has only awarded stock options
to its employees with exercise prices equal to the fair market
value of the stock at the date of grant. Amounts below include
options granted to employees of Timm Medical, which are not
significant.
The following tables summarize the Companys option
activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31, | |
|
|
| |
|
|
2003 | |
|
2004 | |
|
2005 | |
|
|
| |
|
| |
|
| |
|
|
|
|
Weighted-Avg. | |
|
|
|
Weighted-Avg. | |
|
|
|
Weighted-Avg. | |
|
|
Number of | |
|
Exercise Price | |
|
Number of | |
|
Exercise Price | |
|
Number of | |
|
Exercise Price | |
|
|
Options | |
|
Per Option | |
|
Options | |
|
Per Option | |
|
Options | |
|
Per Option | |
|
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Outstanding, beginning of
year
|
|
|
3,153,427 |
|
|
$ |
8.50 |
|
|
|
5,118,752 |
|
|
$ |
5.06 |
|
|
|
5,361,682 |
|
|
$ |
4.72 |
|
Granted
|
|
|
2,893,000 |
|
|
|
3.42 |
|
|
|
1,397,500 |
|
|
|
2.94 |
|
|
|
1,549,250 |
|
|
|
3.19 |
|
Cancelled
|
|
|
(892,675 |
) |
|
|
11.96 |
|
|
|
(804,570 |
) |
|
|
5.32 |
|
|
|
(709,463 |
) |
|
|
5.80 |
|
Exercised
|
|
|
(35,000 |
) |
|
|
3.73 |
|
|
|
(350,000 |
) |
|
|
0.26 |
|
|
|
(195,229 |
) |
|
|
2.10 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding, end of year
|
|
|
5,118,752 |
|
|
|
5.06 |
|
|
|
5,361,682 |
|
|
|
4.72 |
|
|
|
6,006,240 |
|
|
|
4.27 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options Outstanding | |
|
|
|
|
| |
|
Options Exercisable | |
|
|
|
|
Weighted-Avg. | |
|
|
|
| |
|
|
Number | |
|
Remaining | |
|
|
|
Number | |
|
|
Range Of |
|
Outstanding at | |
|
Contractual Life | |
|
Weighted-Avg. | |
|
Exercisable at | |
|
Weighted-Avg. | |
Exercise Price |
|
December 31, 2005 | |
|
(Number of Years) | |
|
Exercise Price | |
|
December 31, 2005 | |
|
Exercise Price | |
|
|
| |
|
| |
|
| |
|
| |
|
| |
$ 0.18 - 2.03
|
|
|
124,500 |
|
|
|
1.80 |
|
|
$ |
1.29 |
|
|
|
124,500 |
|
|
$ |
1.29 |
|
2.06 - 2.85
|
|
|
2,345,365 |
|
|
|
8.26 |
|
|
|
2.48 |
|
|
|
877,333 |
|
|
|
2.36 |
|
2.88 - 3.25
|
|
|
451,945 |
|
|
|
8.60 |
|
|
|
3.02 |
|
|
|
52,778 |
|
|
|
3.15 |
|
3.26 - 4.00
|
|
|
421,500 |
|
|
|
8.99 |
|
|
|
3.54 |
|
|
|
74,375 |
|
|
|
3.57 |
|
4.01 - 5.06
|
|
|
1,819,209 |
|
|
|
7.99 |
|
|
|
4.31 |
|
|
|
1,059,021 |
|
|
|
4.34 |
|
5.13 - 7.44
|
|
|
278,942 |
|
|
|
5.18 |
|
|
|
5.27 |
|
|
|
278,942 |
|
|
|
5.27 |
|
9.00 - 12.98
|
|
|
293,708 |
|
|
|
5.61 |
|
|
|
10.93 |
|
|
|
272,051 |
|
|
|
10.90 |
|
|
13.42 - 15.00
|
|
|
126,500 |
|
|
|
5.92 |
|
|
|
13.99 |
|
|
|
123,083 |
|
|
|
13.99 |
|
|
15.42 - 21.23
|
|
|
144,571 |
|
|
|
5.88 |
|
|
|
17.42 |
|
|
|
144,430 |
|
|
|
17.42 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
6,006,240 |
|
|
|
7.74 |
|
|
$ |
4.27 |
|
|
|
3,006,513 |
|
|
$ |
5.30 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The weighted average fair value of the Companys options at
the grant date was approximately $3.02 in 2003, $2.22 in 2004,
and $2.25 in 2005.
Employment related taxes payable associated with the exercise of
employee stock options and loan forgiveness at December 31,
2004 and 2005 were $1.2 million and $1.0 million,
respectively (included in accrued compensation).
|
|
10. |
Equity Incentive Plans |
As of December 31, 2005, the Company had options
outstanding under four stock-based compensation plans, as
follows:
2004 Stock Incentive Plan. The 2004 Stock Incentive Plan
adopted in September 2004 authorizes the Board or one or more
committees designated by the Board (the Plan
Administrator) to grant options and rights to purchase
common stock to employees, directors and consultants. Options
may be either incentive
F-23
ENDOCARE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
stock options as defined in Section 422 of the
Internal Revenue Code of 1986, as amended, non-statutory stock
options or other equity instruments. The 2004 Stock Incentive
Plan replaced the 1995 Stock Plan and 1995 Director Plan
described below. The exercise price is equal to the fair market
value of the Companys common stock on the date of grant
(or 110 percent of such fair market value, in the case of
options granted to any participant who owns stock representing
more than 10 percent of the Companys combined voting
power). Options generally vest 25 percent on the one-year
anniversary date, with the remaining 75 percent vesting
monthly over the following three years and are exercisable for
10 years. On the first trading day of each calendar year
beginning in 2005, shares available for issuance will
automatically increase by three percent of the total number of
outstanding common shares at the end of the preceding calendar
year, up to a maximum of 1,000,000 shares. In addition, the
maximum aggregate number of shares which may be issued under the
2004 Stock Incentive Plan will be increased by any shares (up to
a maximum of 2,800,000 shares) awarded under the 1995 Stock
Plan and 1995 Director Plan that are forfeited, expire or
are cancelled. Options become fully vested if an employee is
terminated without cause within 12 months of a change in
control as defined. Upon a corporate transaction as defined,
options not assumed or replaced will vest immediately. Options
assumed or replaced will vest if the employee is terminated
without cause within 12 months. As of December 31,
2005, there were outstanding under the 2004 Stock Incentive Plan
options to purchase 1,970,000 shares of the Companys
common stock, 854,077 options were available for grant, and
2,093,803 shares reserved for issuance.
1995 Stock Plan. The 1995 Stock Plan authorized the Board
or one or more committees designated by the Board (such
committee, the Committee) to grant options and
rights to purchase common stock to employees and certain
consultants and distributors. Options granted under the 1995
Stock Plan may be either incentive stock options as
defined in Section 422 of the Internal Revenue Code of
1986, as amended, non-statutory stock options or other equity
instruments, as determined by the Board or the Committee. The
exercise price of options granted under the 1995 Stock Plan was
required to equal the fair market value of the Companys
common stock on the date of grant. Options generally vest
25 percent on the one-year anniversary date, with the
remaining 75 percent vesting monthly over the following
three years. Options are exercisable for 10 years. The 1995
Stock Plan was replaced by the 2004 Stock Incentive Plan on
September 10, 2004. As of December 31, 2005, there
were outstanding under the 1995 Stock Plan options to
purchase 2,036,240 shares of the Companys common
stock and no options were available for grant.
1995 Director Option Plan. The 1995 Director
Option Plan (the Director Plan) provided automatic,
non-discretionary grants of options to the Companys
non-employee directors (Outside Directors). Upon
election, each director receives an initial option grant to
purchase 20,000 shares of common stock which vest over
two years and an annual option grant to purchase
5,000 common shares which becomes exercisable after one
year. The exercise price of options granted to Outside Directors
was required to be the fair market value of the Companys
common stock on the date of grant. Options granted to Outside
Directors have 10-year
terms, subject to an Outside Directors continued service
as a director. The 1995 Director Option Plan was replaced
by the 2004 Stock Incentive Plan on September 10, 2004. As
of December 31, 2005, there were outstanding under the
1995 Director Option Plan options to purchase
110,000 shares of the Companys common stock and no
options were available for grant.
2002 Supplemental Stock Plan. The Company adopted the
2002 Supplemental Stock Plan (2002 Plan) effective
June 25, 2002. Under the 2002 Plan, non-statutory options
may be granted to employees, consultants and outside directors
with an exercise price equal to at least 85 percent of the
fair market value per share of the Companys common stock
on the date of grant. The 2002 Plan expires June 24, 2012,
unless earlier terminated in accordance with plan provisions.
The 2002 Plan also terminates automatically upon certain
extraordinary events, such as the sale of substantially all of
the Companys assets, a merger in which the Company is not
the surviving entity or acquisition of 50 percent or more
of the beneficial ownership in the Companys common stock
by other parties. Upon such an event, all options become fully
exercisable. Through
F-24
ENDOCARE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
December 31, 2005, there were options to purchase
140,000 shares of the Companys common stock
outstanding under the 2002 Plan and options to
purchase 295,000 shares were available for grant.
Option Arrangements Outside of Plans. In addition to the
option plans described above, on March 3, 2003, the Company
granted options to purchase 750,000 shares of common stock
to the current President and Chief Operating Officer. The
options were granted at $2.25 per share; 250,000 of the
options are available for accelerated vesting based on the
attainment of certain milestones and objectives or five years,
whichever comes first. Twenty-five percent of the remaining
750,000 options vest on the first anniversary with the
balance ratably over three years.
On December 15, 2003, the Company granted 1,000,000 options
to purchase common stock to the Chief Executive Officer. The
options were granted at $4.27 per share; 100,000 of these
options are available for accelerated vesting based on the
attainment of certain milestones and objectives or five years,
whichever comes first. Twenty-five percent of the remaining
options vest immediately with the balance vesting ratably over
three years.
All options granted pursuant to the Companys stock-based
compensation plans are subject to immediate vesting upon a
change in control as defined in the respective plan, except for
special provisions in the case of the 2004 Stock Incentive Plan
as described above.
In April 1999, the Company adopted a stockholder rights plan
(the Plan) in which preferred stock purchase rights were
distributed as a dividend at the rate of one right for each
share of common stock held as of the close of business on
April 15, 1999. The rights are designed to guard against
partial tender offers and other abusive and coercive tactics
that might be used in an attempt to gain control of the Company
or to deprive the Companys stockholders of their interest
in the long-term value of the Company. The rights will be
exercisable only if a person or group acquires 15 percent
or more of the Companys common stock (subject to certain
exceptions stated in the Plan) or announces a tender offer the
consummation of which would result in ownership by a person or
group of 15 percent or more of the Companys common
stock. At any time on or prior to the close of business on the
first date of a public announcement that a person or group has
acquired beneficial ownership of 15 percent or more of the
Companys common stock (subject to certain exceptions
stated in the Plan), the rights are redeemable for
$0.01 per right at the option of the Board of Directors.
The rights will expire at the close of business on
April 15, 2009 (the Final Expiration Date),
unless the Final Expiration Date is extended or unless the
rights are earlier redeemed or exchanged by the Company.
The composition of the federal and state income tax provision
(benefit) from continuing operations is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years Ended | |
|
|
December 31, | |
|
|
| |
|
|
2003 |
|
2004 |
|
2005 | |
|
|
|
|
|
|
| |
|
|
(In thousands) | |
Federal
|
|
$ |
|
|
|
$ |
|
|
|
$ |
(705 |
) |
State
|
|
|
|
|
|
|
|
|
|
|
(124 |
) |
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$ |
|
|
|
$ |
|
|
|
$ |
(829 |
) |
|
|
|
|
|
|
|
|
|
|
The 2005 tax benefit is the result of current year pre-tax book
losses being utilized against pre-tax book income from
discontinued operations. There is an offsetting tax provision
within discontinued operations.
F-25
ENDOCARE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
The following table summarizes the tax effects of temporary
differences, which give rise to significant portions of the
deferred tax assets at December 31:
|
|
|
|
|
|
|
|
|
|
|
|
|
2004 | |
|
2005 | |
|
|
| |
|
| |
|
|
(In thousands) | |
Deferred tax assets (liabilities):
|
|
|
|
|
|
|
|
|
|
Depreciation and amortization
|
|
|
(27 |
) |
|
|
468 |
|
|
Nondeductible reserves and accruals
|
|
|
2,899 |
|
|
|
2,280 |
|
|
Investment in stock of discontinued operation
|
|
|
|
|
|
|
10,468 |
|
|
Research and experimentation tax credit carryforwards
|
|
|
1,000 |
|
|
|
1,000 |
|
|
Net operating loss carryforwards
|
|
|
38,468 |
|
|
|
42,578 |
|
|
Capital loss carryforwards
|
|
|
5,279 |
|
|
|
5,279 |
|
|
Other
|
|
|
752 |
|
|
|
1,417 |
|
|
|
|
|
|
|
|
|
|
|
48,371 |
|
|
|
63,490 |
|
|
Valuation allowance
|
|
|
(48,371 |
) |
|
|
(63,490 |
) |
|
|
|
|
|
|
|
|
|
Net deferred tax assets
|
|
$ |
|
|
|
$ |
|
|
|
|
|
|
|
|
|
During 2005, in connection with the presentation of Timm Medical
Technologies, Inc. (Timm Medical) as a discontinued
operation (see Note 8), the Company recorded a deferred tax
asset of $10.5 million for the tax in excess of financial
statement basis in the stock of Timm Medical. As a result of
continued operating losses and, in 2005, the recording of a
deferred tax asset for the tax in excess of financial statement
basis in the stock of Timm Medical, the valuation allowance
increased by $13.0 million and $15.1 million during
the years ended December 31, 2004 and 2005, respectively.
Due to the Companys history of operating losses,
management has not determined that it is more likely than not
that the Companys deferred tax assets will be realized
through future earnings. Accordingly, valuation allowances have
been recorded to fully reserve the Companys deferred tax
assets as of December 31, 2004 and 2005.
Actual income tax expense differs from amounts computed by
applying the United States federal income tax rate of
34 percent to pretax loss as a result of the following:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years Ended December 31, | |
|
|
| |
|
|
2003 | |
|
2004 | |
|
2005 | |
|
|
| |
|
| |
|
| |
|
|
(In thousands) | |
Computed expected tax benefit
|
|
$ |
(8,487 |
) |
|
$ |
(10,846 |
) |
|
$ |
(5,327 |
) |
Nondeductible expenses
|
|
|
287 |
|
|
|
78 |
|
|
|
89 |
|
Increase in valuation allowance
|
|
|
9,572 |
|
|
|
12,950 |
|
|
|
4,490 |
|
State taxes
|
|
|
(1,372 |
) |
|
|
(1,861 |
) |
|
|
(81 |
) |
Other
|
|
|
|
|
|
|
(321 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Actual tax expense (benefit)
|
|
$ |
|
|
|
$ |
|
|
|
$ |
(829 |
) |
|
|
|
|
|
|
|
|
|
|
As of December 31, 2005, the Company has federal and
California net operating loss carryforwards of
$108.5 million and $33.6 million, respectively. The
Company also has approximately $60.8 million in net
operating loss carryforwards in various other states. The
federal net operating loss carryforwards begin to expire in 2011
and the state net operating loss carryforwards begin to expire
in 2006. In addition, the Company has federal and state research
and experimentation credit carryforwards of $0.7 million
and $0.3 million, respectively. The federal research and
experimentation credit carryforwards begin to expire in 2011 and
the state research and experimentation credit carryforwards do
not expire.
F-26
ENDOCARE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
IRC Sections 382 and 383 limit the annual utilization of
net operating loss and tax credit carryforwards existing prior
to a change in control. Based upon prior equity transaction
activity, some or all of the Companys existing net
operating loss and tax credit carryforwards may be subject to
annual limitations under IRC Sections 382 and 383. The
Company has not performed an analysis to determine whether such
change in control has occurred for tax reporting purposes and if
so, the specific limitations that may result.
|
|
12. |
Collaborative and Other Agreements |
In October 1999, the Company entered into a strategic alliance
with Sanarus Medical, Inc. (Sanarus), a privately held medical
device company. The Company received 200,041 Series A
voting convertible preferred shares for $0.3 million and a
warrant to acquire 3,166,000 common shares for $0.01 per
share in consideration for entering into a manufacturing, supply
and license agreement (the 1999 Agreement). The 1999
Agreement provided Sanarus an exclusive, royalty-free, worldwide
non-sublicenseable right to develop, manufacture and sell
products using cryoablation technology developed by the Company
for use in the field of gynecology and breast diseases. The
warrant is exercisable at any time through October 12,
2009. In June 2001, the 1999 Agreement was amended (the 2001
Agreement) to provide for (i) the termination of
Sanaruss exclusive, royalty-free, worldwide
non-sublicenseable right under the 1999 Agreement;
(ii) Sanaruss grant to the Company of an exclusive
(even as to Sanarus), worldwide, irrevocable, fully
paid-up right to
develop, manufacture and sell products using certain Sanarus
technology for use in the diagnosis, prevention and treatment of
prostate, kidney and liver diseases, disorders and conditions;
and (iii) the Companys grant to Sanarus of an
exclusive (even as to the Company), worldwide, irrevocable,
fully paid-up right to
develop, manufacture and sell products using certain of the
Companys technology for use in the diagnosis, prevention
and treatment of gynecological and breast diseases, disorders
and conditions.
In June 2001, the Company provided a bridge loan to Sanarus in
the amount of $0.3 million and received a warrant to
purchase 36,210 shares of Series B voting
preferred stock. The loan was repaid in July 2001. In April
2003, the Company and other investors entered into a second
bridge loan financing in which Sanarus issued to the Company a
convertible promissory note in the aggregate amount of
$0.6 million and a warrant to purchase equity shares in
Sanarus with an aggregate exercise price of up to
$0.3 million. Upon completion of an equity financing by
Sanarus in October 2003, the bridge loan and warrant were
canceled in exchange for 908,025 shares of Series C
voting preferred stock and a warrant to purchase 308,823
Series C shares at $0.68 per share. As of
December 31, 2005 and 2004, the Companys voting
interest in Sanarus was approximately 5.2 percent.
The Companys former Chief Executive Officer and Chairman
of the Board was a member of Sanaruss Board of Directors
through October 22, 2003. A former member of the
Companys Board of Directors is also a member of
Sanaruss Board of Directors, and is an officer and partner
in a venture fund that in the aggregate beneficially owns more
than 10 percent of the outstanding Series A preferred
stock of Sanarus. The total investment in Sanarus of
$0.9 million as of December 31, 2004 and 2005 is
included in investments and other assets. The investment is
recorded at cost since the Company does not exercise significant
influence over the operations of Sanarus.
Effective December 21, 2004, the Company and CryoFluor
Therapeutics, LLC (CryoFluor) entered into a
Services Agreement and First Amendment to CryoFluors
Operating Agreement. Under the Services Agreement, the Company
will provide to CryoFluor certain product design and development
services, which consist of both preclinical stage services and
clinical stage services.
F-27
ENDOCARE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
In exchange for the preclinical stage services, CryoFluor issued
500,000 ownership units to the Company on December 21,
2004, which are subject to vesting as described below. In
exchange for the clinical stage services, the Services Agreement
provides that on an agreed upon date (the Second
Tranche Date), CryoFluor shall issue to the Company
an additional 445,000 ownership units subject to completion
of the preclinical services and compliance with all of the
Companys obligations to be performed by the Second
Tranche Date. Each ownership unit has an ascribed value of
$1.00.
The ownership units are subject to vesting as follows:
(i) 50,000 of the units vested on December 21, 2004;
(ii) 44,500 units upon the Second Tranche Date;
(iii) 450,000 units upon completion of the preclinical
services and CryoFluors acceptance of the Companys
report relating to the preclinical services; and (iv) the
remaining 400,500 units upon completion of the clinical
services and CryoFluors acceptance of the Companys
report relating to the clinical services. In the event of a
termination of the Services Agreement for any reason, all
ownership units that have not vested as of the termination date
will be forfeited. As of December 31, 2005, the Company
completed the preclinical services and has vested in
500,000 units constituting 13 percent of
CryoFluors outstanding ownership interests as of such date.
Pursuant to the First Amendment to the Operating Agreement, the
Company was admitted as a member of CryoFluor on
December 21, 2004. Each other member of CryoFluor granted
to the Company a limited right of first negotiation with respect
to the sale of ownership units held by such member. In addition,
CryoFluor granted to the Company a limited right of first
negotiation with respect to the sale, assignment, license or
other transfer of the technology owned by CryoFluor that is the
subject of the development program under the Services Agreement.
Since CryoFluor is a development stage company and the fair
value of the Companys contracted services could not be
accurately determined, the Company has recorded a valuation
allowance against the ascribed value of its minority interest
investment in CryoFluor. The Company accounted for its
investment in CryoFluor using the cost method.
|
|
|
CryoDynamics, LLC Research & Development
Agreement |
On November 8, 2005, the Company entered into a
commercialization agreement (the Agreement) with
CryoDynamics, LLC to design and develop a cryosurgical system
utilizing nitrogen gas. The parties will jointly own all rights
relating to the technology (Development Inventions). To assist
CryoDynamics in its research and development efforts, the
Company will advance CryoDynamics $42,500 per month,
effective October 1, 2005 until such time as either party
enters into a license agreement based upon the nitrogen system
with an independent third party that results in CryoDynamics
receiving an amount sufficient to repay the advances.
Under the Agreement, CryoDynamics grants to the Company an
exclusive, worldwide license (with the right to sublicense) to
the Development Inventions and pre-existing technology in all
medical fields of use. The Company will also grant to
CryoDynamics an exclusive, worldwide license (with the right to
sublicense) to such Development Inventions in specified fields
of use. Royalties and license fees will be determined in
accordance with the Agreement. The Agreement also provides for a
right of first refusal should CryoDynamics intend to accept an
offer from any potential buyer for the sale of all or part of
CryoDynamicss business.
The Agreement will continue until the later of
(a) December 31, 2015, or (b) expiration of the
parties obligations to pay royalties, or until the
Agreement is terminated because of breach, insolvency or
bankruptcy.
Since repayment of amounts advanced under the agreement is
contingent upon the successful development, commercialization
and licensing of the technology and is not reasonably assured,
these advances will be expensed as incurred. The Company
recorded $0.1 million of research and development costs for
the year ended December 31, 2005 in connection with the
Agreement.
F-28
ENDOCARE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
|
|
|
Patent, Licensing, Royalty and Distribution Agreements |
The Company has entered into other patent, licensing and royalty
agreements with third parties, some of whom also have consulting
agreements with the Company and are owners of or affiliated with
entities which have purchased products from the Company. These
agreements historically generally provide for purchase
consideration in the form of cash, common shares, warrants or
options and royalties based on a percentage of sales related to
the licensed technology, subject to minimum amounts per year.
The patents and licensing rights acquired are recorded based on
the fair value of the consideration paid. Options and warrants
issued are valued using the Black-Scholes option pricing model.
These assets are amortized over their respective estimated
useful lives. Royalty payments are expensed as incurred.
The Company has entered into additional distribution agreements
with third parties. These agreements govern all terms of sale,
including shipping terms, pricing, discounts and minimum
purchase quotas, if applicable. Pricing is fixed and
determinable and the distributors contractual obligation
to pay is not contingent on other events, such as final sale to
an end-user. The Company generally does not grant a right of
return except for defective products in accordance with its
warranty policy, and in some cases for unsold inventory within a
limited time period upon the termination of the distribution
agreement.
|
|
13. |
Commitments and Contingencies |
The Company leases office space and equipment under operating
leases, which expire at various dates through 2007. Some of
these leases contain renewal options and rent escalation
clauses. Future minimum lease payments by year and in the
aggregate under all non-cancelable operating leases consist of
the following (in thousands):
|
|
|
|
|
Year ending December 31, 2006
|
|
$ |
553 |
|
2007
|
|
|
120 |
|
2008
|
|
|
13 |
|
|
|
|
|
|
|
$ |
686 |
|
|
|
|
|
|
|
|
Employment and Severance Agreements |
The Company has entered into employment agreements with certain
executives which provide for annual base salaries and cash
incentive payments of up to 85 percent of base salary
subject to attainment of corporate goals and objectives pursuant
to incentive compensation programs approved by the
Companys board of directors, and stock options. The
agreements provide for severance payments if the executive is
terminated other than for cause or terminates for good reason as
defined. The options vest over specified time periods with
accelerated vesting upon attainment of performance targets in
certain instances.
|
|
|
Former Chief Executive Officer and Chairman of the Board |
The Company entered into a Separation Agreement and a one-year
Consulting Agreement with the Companys former Chief
Executive Officer and Chairman of the Board (the former
CEO), each effective as of July 31, 2003. Under the
Separation Agreement, the former CEO was entitled to receive a
$0.4 million severance payment, in addition to accrued and
unpaid wages and unused vacation time. The former CEO waived all
rights to which he is or may be entitled under the
Companys 2002 Separation Benefits Plan. In exchange for an
additional $0.4 million upfront payment, under the
provisions of the Consulting Agreement, as amended, the former
CEO agreed to a one-year covenant not to compete and during its
term, he was
F-29
ENDOCARE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
required to provide consulting services at the direction of
management for a minimum of eight hours per quarter. The former
CEO continued to participate in the Companys benefit plans
for 24 months. Of the former CEOs outstanding vested
stock options, 565,000 will continue to remain outstanding as
permitted under the 1995 Stock Plan, and 200,000 of his
outstanding stock options were terminated. The Company recorded
a charge of $0.8 million in the third quarter of 2003 for
the severance and related benefits. The Separation Agreement and
Consulting Agreement further provide that the former CEO is
required to repay the severance payment and consulting fees
received upon either (i) his conviction in a court of law,
or entering into a plea of guilt or no contest to, any crime
directly relating to his activities on behalf of the Company
during his employment, or (ii) successful prosecution of an
enforcement action by the SEC against him. The total severance
payment due of $0.8 million was deposited into an escrow
account and was released from the escrow account in March 2004.
In the third quarter of 2004, the former CEO exercised options
to purchase 325,000 shares at $0.18 per share.
Options for the remaining 240,000 shares expired
unexercised.
|
|
|
Former Chief Financial Officer and Chief Operating Officer |
The Company entered into an employment agreement, dated
March 3, 2003 (the Employment Agreement), with
the Companys former Chief Financial Officer and Chief
Operating Officer (the former CFO/COO). Under the
agreement, the Company was required to pay the former CFO/COO a
base salary of $0.2 million and cash bonus of up to
$88,000 per year. The Employment Agreement also provided
that all of the former CFO/COOs options to
purchase 385,000 shares of common stock would be
cancelled and replaced by immediately exercisable options to be
granted between September 4, 2003 and November 3,
2003. The replacement options were issued on October 30,
2003 at an exercise price of $4.50 per share, which is
equal to the fair market value of the common stock on the date
of grant.
The Employment Agreement also provided that upon any Qualified
Termination (as defined), the former CFO/COO would be entitled
to a cash payment of $0.6 million, continued participation
in the Companys benefit plans for 24 months, a
$50,000 relocation allowance and an additional payment to cover
the tax liabilities relating to the allowance. Effective
July 31, 2003, the Company terminated the former
CFO/COOs employment other than for cause. The Company
recorded a third quarter charge for $0.7 million for
severance, medical, and relocation benefits due under the
Qualified Termination provisions. In addition, the Company
recorded a third quarter charge for $1.7 million for the
fair value of the 385,000 replacement options determined using
the Black-Scholes option pricing model.
Under the Employment Agreement, the former CFO/COO is required
to repay all amounts received in a Qualified Termination upon
(i) the former CFO/COOs conviction in a court of law,
or entering into a plea of guilt or no contest to, any crime
directly relating to his activities on behalf of the Company
during his employment, or (ii) successful prosecution of an
enforcement action by the SEC against the former CFO/COO. The
total severance payments due of $0.6 million were deposited
into an escrow account and were released from the escrow account
in March 2004.
|
|
|
Former Chief Financial Officer |
On August 27, 2004, the Company executed a General Release
of All Claims (the General Release) with its then
Chief Financial Officer (the former CFO), which was
effective as of August 10, 2004. Pursuant to the terms of
the General Release, the Company agreed to continue to pay the
former CFO her current base salary of $0.2 million per year
via semi-monthly salary continuation payments for a period of
12 months and continuation of her health benefits pursuant
to COBRA for one year. Finally, the Company agreed to permit the
former CFO to continue to vest in all stock options previously
granted by the Company through July 31, 2005 and recorded
stock-based compensation expense of $0.1 million. In 2005
and 2004, the former CFO exercised options for the purchase of
130,208 and 15,625 common shares, respectively. The remaining
vested options expired unexercised.
F-30
ENDOCARE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
|
|
|
2002 Executive Separation Benefits Plan |
Effective July 17, 2002, the Company adopted the 2002
Executive Separation Benefits Plan (Separation Plan)
to provide separation benefits to certain designated employees.
The Separation Plan provided that, in the case of any
Covered Termination, the participants would receive
from six months to two years of their base salary plus the
maximum bonus, as defined. Covered Terminations included
termination by the employee for good reason after a change in
control, by the employee for any or no reason during the
30-day period
immediately following the six-month anniversary of a change in
control, or voluntarily by the Company or its successor after a
change in control for a reason other than cause, death or
disability. Participants were also entitled to continued
eligibility for the Companys benefit program for a period
equal to the number of months of base pay to be received.
Effective July 2004, the Company terminated the Separation Plan.
The Company has a 401(k) savings plan covering substantially all
employees. The Plan currently provides for a discretionary match
of amounts contributed by each participant as approved by the
Compensation Committee of the Board of Directors. No matching
contributions were made in 2003, 2004 or 2005.
The Company has 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 the Company and certain of its
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 of the SEC and remains subject both to final approval
by the SEC and court, includes the following principal terms:
(i) the Company would pay a total of $750,000 in civil
penalties (accrued during the year ended December 31,
2004); (ii) the Company would agree to a stipulated
judgment enjoining future violations of securities laws; and
(iii) the Company would agree to maintain various
improvements in the Companys internal controls that have
previously been implemented. If approved, the proposed
settlement would resolve all claims against the Company relating
to the formal investigation that the SEC commenced in January
2003.
The Department of Justice (DOJ) is conducting an
investigation into allegations that the Company and certain of
its former officers, a former director and one current employee
intentionally issued, or caused to be issued, false and
misleading statements regarding the Companys financial
results and related matters. The DOJs investigation is
ongoing and is not affected by the proposed settlement with the
SEC described above.
The Company carries $20 million of directors and
officers liability insurance coverage under four policies
with limits of $5 million each. The primary carrier
reimbursed the Companys defense costs up to the limits of
its $5 million policy. However, the three excess carriers,
representing $15 million of the $20 million of
coverage, filed arbitration complaints seeking rescission of the
policies. In December 2004 and February 2005, the Company
reached settlement with two of the three excess carriers to
reimburse the Company for current and future legal defense and
litigation settlement costs totaling $6.3 million. On
December 1, 2005, the Company entered into a settlement
agreement with the third excess carrier pursuant to which the
Company returned $1.0 million of the $5.0 million
previously funded by the carrier toward litigation settlement
costs. Under the settlement agreements, the Company also granted
mutual releases to each of the carriers.
In November 2002, the Company was sued in an action filed by
BioLife in the Delaware Court of Chancery. BioLife sought
damages for alleged breaches of contract stemming from the
Companys acquisition of the tangible and intangible assets
related to BioLifes cryosurgical business. BioLife alleged
that the Company failed to timely register 120,022 shares
of the Companys common stock provided to BioLife as
partial consideration for the asset acquisition, in violation of
a registration rights agreement relating to the
F-31
ENDOCARE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
shares issued to BioLife. On October 1, 2003, BioLife was
awarded $1.6 million plus prejudgment interest and costs
(including legal fees) and BioLife was required to surrender the
120,022 shares to the Company. As a result of this
decision, the Company recorded a 2002 fourth quarter charge of
$1.5 million, representing the difference between the
courts award to BioLife and the estimated fair value of
the shares to be surrendered. On October 10, 2003 the
Company filed a notice of appeal. On February 20, 2004, the
Company agreed to abandon the appeal in exchange for a cash
payment of $1.9 million to BioLife and return of the
120,022 common shares. The shares were recorded as treasury
stock in March 2004 based on the fair value of $0.5 million
at that date and the balance of $1.4 million was applied
against a litigation accrual previously recorded in 2002 and
included in other accrued liabilities at December 31, 2003.
In November 2002, the Company was 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 the
Companys revenues and expenses in press releases and SEC
filings. Plaintiffs sought class certification and unspecified
damages from the Company, 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 the Companys motion to dismiss the
consolidated complaint. On November 8, 2004, the Company
executed a settlement agreement with the lead plaintiffs and
their counsel. The court has granted preliminary approval of
this agreement and authorized the parties to provide notice of
its terms to class members. Under the agreement, in exchange for
a release of all claims, the Company and certain individuals
would pay a total of $8.95 million in cash. The
Companys 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.
On December 6, 2002, Frederick Venables filed a purported
derivative action against the Company 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 the Companys revenues
and expenses in press releases and SEC filings. On
December 6, 2004, the Company 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, the Company 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 the
Company 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 the Companys Board
of Directors.
In December 2002, the Company filed a demand for arbitration
before the American Arbitration Association in Minnesota against
a former employee. The complaint included various claims in
response to which the employee made several counterclaims. In
March 2003, the Company was notified by the United States
Department of Labor that counsel for the employee had presented
a letter of complaint alleging that the Company, its former CEO
and former CFO/COO violated 18 U.S.C. § 1514A by
improperly retaliating against the employee. In December 2003,
the Company and the employee agreed to settle all claims on
mutually acceptable terms without the admission of liability by
any party for an amount that is not significant.
F-32
ENDOCARE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
Pursuant to the settlement, the employee withdrew his letter of
complaint, and the Department of Labor has indicated that it
considers this matter closed.
In addition, the Company, in the normal course of business, is
subject to various other legal matters, which management
believes will not individually or collectively have a material
adverse effect on the Companys results of operations or
cash flows of a future period. The results of litigation and
claims cannot be predicted with certainty, and the Company
cannot provide assurance that the outcome of various legal
matters will not have a material adverse effect on its
consolidated financial condition, results of operations or cash
flows. As of December 31, 2005, except for the matters
indicated above for which the Company has accrued
$0.8 million, the Company has 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. The Company has
purchased directors and officers liability and other
insurance which 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.
From time to time, the Company has received other 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 that
the Company 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.
Management does not expect any material adverse effect on the
consolidated financial condition, the results of operations, or
cash flows because of such actions.
On October 26, 2005, the Company 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. The Company has not
incurred any borrowing under this arrangement as of and
subsequent to December 31, 2005.
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 the Companys quick
ratio, as defined. The revolving line of credit is
collateralized by substantially all of the Companys assets.
The Loan and Security Agreement contains various financial and
operating covenants that impose limitations on the
Companys 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.
|
|
15. |
Related Party Transactions |
In February 2002, the Company purchased the patents to certain
cryosurgical technologies and a covenant not to compete from a
cryosurgeon inventor for 100,000 shares of the
Companys common stock valued at $1.4 million, of
which $1.1 million (75,000 shares) was allocated to
the patent to be amortized over 15 years and the remaining
$0.3 million (25,000 shares) was allocated to the
covenant to be amortized over five years.
The agreement also requires the seller to perform certain
consulting services over 15 years for the consideration
received. No consideration was allocated to the consulting
agreement since its value could not be accurately measured. In
January 2003, the Company extended a $344,000 loan to the seller
to assist with the payment of related federal income taxes
arising from the 2002 asset sale. The loan is secured by the
shares issued, bears interest at 1.8 percent and is due in
January 2007.
F-33
ENDOCARE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
|
|
16. |
Quarterly Results of Operations (Unaudited) |
The following is a summary of the quarterly results of
operations for the years ended December 31, 2005 and 2004
(in thousands, except per share data).
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quarter Ended | |
|
Quarter Ended | |
|
Quarter Ended | |
|
Quarter Ended | |
|
|
March 31, | |
|
June 30, | |
|
September 30, | |
|
December 31, | |
|
|
2005 | |
|
2005 | |
|
2005 | |
|
2005 | |
|
|
| |
|
| |
|
| |
|
| |
Revenues from continuing operations
|
|
$ |
6,867 |
|
|
$ |
6,919 |
|
|
$ |
7,008 |
|
|
$ |
7,481 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of revenues from continuing operations
|
|
$ |
4,186 |
|
|
$ |
3,924 |
|
|
$ |
3,809 |
|
|
$ |
3,819 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss from continuing operations
|
|
$ |
(5,219 |
) |
|
$ |
(4,522 |
) |
|
$ |
(2,997 |
) |
|
$ |
(2,101 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss
|
|
$ |
(4,506 |
) |
|
$ |
(4,196 |
) |
|
$ |
(2,460 |
) |
|
$ |
(2,517 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss from continuing operations per share of common
stock basic and diluted
|
|
$ |
(0.17 |
) |
|
$ |
(0.15 |
) |
|
$ |
(0.10 |
) |
|
$ |
(0.07 |
) |
Net loss per share of common stock basic and diluted
|
|
$ |
(0.15 |
) |
|
$ |
(0.14 |
) |
|
$ |
(0.08 |
) |
|
$ |
(0.08 |
) |
Weighted average shares of common stock outstanding
basic and diluted
|
|
|
29,988 |
|
|
|
30,060 |
|
|
|
30,069 |
|
|
|
30,081 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quarter Ended | |
|
Quarter Ended | |
|
Quarter Ended | |
|
Quarter Ended | |
|
|
March 31, | |
|
June 30, | |
|
September 30, | |
|
December 31, | |
|
|
2004 | |
|
2004 | |
|
2004 | |
|
2004 | |
|
|
| |
|
| |
|
| |
|
| |
Revenues from continuing operations
|
|
$ |
5,325 |
|
|
$ |
6,244 |
|
|
$ |
6,223 |
|
|
$ |
6,389 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of revenues from continuing operations
|
|
$ |
3,302 |
|
|
$ |
3,355 |
|
|
$ |
3,485 |
|
|
$ |
3,443 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss on divestitures, net
|
|
$ |
|
|
|
$ |
|
|
|
$ |
|
|
|
$ |
(711 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss from continuing operations
|
|
$ |
(8,441 |
) |
|
$ |
(5,414 |
) |
|
$ |
(13,467 |
) |
|
$ |
(4,579 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss
|
|
$ |
(8,623 |
) |
|
$ |
(5,620 |
) |
|
$ |
(19,257 |
) |
|
$ |
(4,118 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss from continuing operations per share of common
stock basic and diluted
|
|
$ |
(0.35 |
) |
|
$ |
(0.23 |
) |
|
$ |
(0.56 |
) |
|
$ |
(0.19 |
) |
Net loss per share of common stock basic and diluted
|
|
$ |
(0.36 |
) |
|
$ |
(0.23 |
) |
|
$ |
(0.80 |
) |
|
$ |
(0.17 |
) |
Weighted average shares of common stock outstanding
basic and diluted
|
|
|
24,088 |
|
|
|
24,000 |
|
|
|
24,175 |
|
|
|
24,342 |
|
F-34
ENDOCARE, INC. AND SUBSIDIARIES
SCHEDULE II VALUATION AND QUALIFYING
ACCOUNTS
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Additions |
|
|
|
|
|
|
Balance at the | |
|
|
|
|
|
Balance at | |
|
|
Beginning of | |
|
Charges to | |
|
|
|
|
|
the End of | |
|
|
the Period | |
|
Operations | |
|
Other |
|
Deductions | |
|
the Period | |
|
|
| |
|
| |
|
|
|
| |
|
| |
|
|
(In thousands) | |
2003
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Allowance for Doubtful Receivables and Sales Returns
|
|
$ |
1,624 |
|
|
$ |
658 |
|
|
$ |
|
|
|
$ |
(296 |
) |
|
$ |
1,986 |
|
2004
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Allowance for Doubtful Receivables and Sales Returns
|
|
$ |
1,986 |
|
|
$ |
(726 |
) |
|
$ |
|
|
|
$ |
(1,186 |
) |
|
$ |
74 |
|
2005
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Allowance for Doubtful Receivables and Sales Returns
|
|
$ |
74 |
|
|
$ |
10 |
|
|
$ |
|
|
|
$ |
(14 |
) |
|
$ |
70 |
|
Amounts exclude discontinued operations.
F-35
EXHIBIT INDEX
|
|
|
|
|
Exhibit No. |
|
Description |
|
|
|
|
2 |
.1(1) |
|
Partnership Interest Purchase Agreement, dated as of
December 30, 2004, by and between the Company and Advanced
Medical Partners, Inc. |
|
2 |
.2(2) |
|
Stock Purchase Agreement, dated as of January 13, 2006, by
and among Plethora Solutions Holdings plc, Endocare, Inc. and
Timm Medical Technologies, Inc. The schedules and other
attachments to this exhibit were omitted. The Company agrees to
furnish a copy of any omitted schedules or attachments to the
Securities and Exchange Commission upon request. |
|
2 |
.3 |
|
$1,425,000 Secured Convertible Promissory Note, dated as of
February 10, 2006, from Plethora Solutions Holdings plc to
Endocare, Inc. |
|
3 |
.1(3) |
|
Certificate of Amendment of Restated Certificate of
Incorporation of the Company. |
|
3 |
.2(3) |
|
Certificate of Designation of Series A Junior Participating
Preferred Stock of the Company. |
|
3 |
.3(3) |
|
Restated Certificate of Incorporation. |
|
3 |
.4(4) |
|
Amended and Restated Bylaws of the Company. |
|
4 |
.1(5) |
|
Form of Stock Certificate. |
|
4 |
.2(6) |
|
Form of Series A Warrant. |
|
4 |
.3(6) |
|
Form of Series B Warrant. |
|
4 |
.4(7) |
|
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(8) |
|
Amendment No. 1 to Rights Agreement, dated as of
September 24, 2005, between the Company and U.S. Stock
Transfer Corporation. |
|
10 |
.1(9) |
|
Lease Agreement, dated November 26, 2001 by and between the
Company and the Irvine Company. |
|
10 |
.2(9) |
|
Form of Indemnification Agreement by and between the Company and
its directors. |
|
10 |
.3(9) |
|
Form of Indemnification Agreement by and between the Company and
its executive officers. |
|
10 |
.4(10) |
|
1995 Director Option Plan (as amended and restated through
March 2, 1999). |
|
10 |
.5(11) |
|
1995 Stock Plan (as amended and restated through
December 30, 2003). |
|
10 |
.6(12) |
|
2002 Supplemental Stock Plan. |
|
10 |
.7(12) |
|
2002 Executive Separation Benefits Plan. |
|
10 |
.8(13) |
|
Employment Agreement, dated as of March 3, 2003, by and
between the Company and William J. Nydam. |
|
10 |
.9(14) |
|
Consulting Agreement, dated as of August 27, 2003, by and
between the Company and Craig T. Davenport. |
|
10 |
.10(15) |
|
Employment Agreement, dated as of December 15, 2003, by and
between the Company and Craig T. Davenport. |
|
10 |
.11(16) |
|
Employment Agreement, dated as of August 11, 2004, by and
between the Company and Michael R. Rodriguez. |
|
10 |
.12(17) |
|
2004 Stock Incentive Plan. |
|
10 |
.13(18) |
|
2004 Non-Employee Director Option Program under 2004 Stock
Incentive Plan. |
|
10 |
.14(18) |
|
Form of Award Agreement Under 2004 Stock Incentive Plan. |
|
10 |
.15(18) |
|
Stipulation of Settlement, dated as of November 1, 2004,
relating to securities class action lawsuit. |
|
10 |
.16(18) |
|
Description of Craig Davenport salary adjustment, effective
December 2004. |
|
10 |
.17(18) |
|
Confidential Settlement Agreement and Release, dated as of
December 14, 2004, by and between the Company and certain
Underwriters at Lloyds, London. |
|
10 |
.18(18) |
|
Release and Settlement Agreement, dated as of December 16,
2004, by and between the Company and National Union Fire
Insurance Company. |
|
|
|
|
|
Exhibit No. |
|
Description |
|
|
|
|
10 |
.19(19) |
|
Description of William J. Nydam salary adjustment,
effective February 2005. |
|
10 |
.20(19) |
|
Description of Michael R. Rodriguez salary adjustment,
effective February 2005. |
|
10 |
.21(19) |
|
Confidential Settlement Agreement and Release, dated as of
February 18, 2005, by and between the Company and Great
American E&S Insurance Company. |
|
10 |
.22(20) |
|
2004 Management Incentive Compensation Program. |
|
10 |
.23(20) |
|
2005 Management Incentive Compensation Program. |
|
10 |
.24(6) |
|
Purchase Agreement, dated as of March 10, 2005, by and
between the Company and the Investors (as defined therein). |
|
10 |
.25(6) |
|
Registration Rights Agreement, dated as of March 10, 2005,
by and between Endocare and the Investors (as defined therein). |
|
10 |
.26(21) |
|
First Amendment to Employment Agreement with Craig T.
Davenport, dated as of April 28, 2005. |
|
10 |
.27(22) |
|
Description of director compensation, as amended on
September 14, 2005. |
|
10 |
.28 |
|
Loan and Security Agreement, dated as of October 26, 2005,
by and among Endocare, Inc., Timm Medical Technologies, Inc. and
Silicon Valley Bank. |
|
10 |
.29 |
|
Commercialization Agreement, dated as of November 8, 2005,
by and between Endocare, Inc. and CryoDynamics, LLC. |
|
10 |
.30 |
|
Confidential Settlement Agreement and Release, dated as of
December 1, 2005, by and between Endocare, Inc. and Liberty
Mutual Insurance Company. |
|
21 |
.1(23) |
|
Subsidiaries of Registrant. |
|
23 |
.1 |
|
Consent of Independent Registered Public Accounting Firm. |
|
24 |
.1 |
|
Power of Attorney, included on signature page. |
|
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. |
|
|
|
|
|
Management contract or compensatory plan or arrangement. |
|
|
(1) |
Previously filed as an exhibit to our
Form 8-K filed on
January 6, 2005. |
|
(2) |
Previously filed as an exhibit to our
Form 8-K filed on
January 18, 2006. |
|
(3) |
Previously filed as an exhibit to our Registration Statement on
Form S-3 filed on
September 20, 2001. |
|
(4) |
Previously filed as an exhibit to our
Form 10-K filed on
March 15, 2004. |
|
(5) |
Previously filed as an exhibit to our
Form 10-K for the
year ended December 31, 1995. |
|
(6) |
Previously filed as an exhibit to our
Form 8-K filed on
March 16, 2005. |
|
(7) |
Previously filed as an exhibit to our
Form 8-K filed on
June 3, 1999. |
|
(8) |
Previously filed as an exhibit to our
Form 8-K filed on
June 28, 2005. |
|
(9) |
Previously filed as an exhibit to our
Form 10-K filed on
March 29, 2002. |
|
|
(10) |
Previously filed as an exhibit to our Registration Statement on
Form S-8 filed on
June 2, 1999. |
|
(11) |
Previously filed as an appendix to our Definitive Proxy
Statement filed on December 3, 2003. |
|
(12) |
Previously filed as an exhibit to our
Form 10-K filed on
December 3, 2003. |
|
(13) |
Previously filed as an exhibit to our
Form 8-K filed on
March 27, 2003. |
|
(14) |
Previously filed as an exhibit to our
Form 10-K filed on
March 15, 2004. |
|
(15) |
Previously filed as an exhibit to our
Form 8-K filed on
December 16, 2003. |
|
(16) |
Previously filed as an exhibit to our
Form 8-K filed on
August 12, 2004. |
|
(17) |
Previously filed as an appendix to our Definitive Proxy
Statement filed on August 6, 2004. |
|
|
(18) |
Previously filed as an exhibit to our
Form 10-K filed on
March 16, 2005. |
|
(19) |
Previously filed as an exhibit to our
Form 10-Q filed on
May 10, 2005. |
|
(20) |
Previously filed as an exhibit to our
Form 8-K filed on
March 1, 2005. |
|
(21) |
Previously filed as an exhibit to our
Form 8-K filed on
May 3, 2005. |
|
(22) |
Previously filed as an exhibit to our
Form 8-K filed on
September 16, 2005. Our director compensation program was
subsequently amended on February 23, 2006, as described in
our Form 8-K filed
on March 1, 2006. |
|
(23) |
Not applicable because, as a result of our sale of Timm Medical
on February 10, 2006, we do not have any subsidiaries that
constitute significant subsidiaries under
Rule 1-02(w) of
Regulation S-X.
|