LANGER,
INC. AND SUBSIDIARIES
Condensed
Consolidated Balance Sheets
|
|
September 30,
2007
|
|
December 31,
2006
|
|
|
|
(Unaudited)
|
|
|
|
Assets
|
|
|
|
|
|
Current
assets:
|
|
|
|
|
|
|
|
Cash
and cash equivalents
|
|
$
|
1,821,005
|
|
$
|
29,766,997
|
|
Accounts
receivable, net of allowances for doubtful accounts and returns and
allowances aggregating $768,538 and $539,321, respectively
|
|
|
10,809,628
|
|
|
4,601,870
|
|
Inventories,
net
|
|
|
7,853,925
|
|
|
3,275,113
|
|
Prepaid
expenses and other current assets
|
|
|
1,888,079
|
|
|
891,357
|
|
Restricted
cash - escrow
|
|
|
1,000,000
|
|
|
—
|
|
Total
current assets
|
|
|
23,372,637
|
|
|
38,535,337
|
|
Property
and equipment, net
|
|
|
15,199,801
|
|
|
8,245,417
|
|
Identifiable
intangible assets, net
|
|
|
14,886,276
|
|
|
5,960,590
|
|
Goodwill
|
|
|
22,100,906
|
|
|
14,119,213
|
|
Other
assets
|
|
|
1,246,816
|
|
|
1,988,913
|
|
Total
assets
|
|
$
|
76,806,436
|
|
$
|
68,849,470
|
|
|
|
|
|
|
|
|
|
Liabilities
and Stockholders’ Equity
|
|
|
|
|
|
|
|
Current
liabilities:
|
|
|
|
|
|
|
|
Other
current liabilities, including current installments of note
payable
|
|
$
|
4,383,775
|
|
$
|
3,474,991
|
|
Accounts
payable
|
|
|
3,869,819
|
|
|
1,173,836
|
|
Unearned
revenue
|
|
|
535,029
|
|
|
574,415
|
|
Total
current liabilities
|
|
|
8,788,623
|
|
|
5,223,242
|
|
Non
current liabilities:
|
|
|
|
|
|
|
|
Long-term
debt:
|
|
|
|
|
|
|
|
5%
Convertible notes, net of debt discount of $412,701 at September
30,
2007
|
|
|
28,467,299
|
|
|
28,880,000
|
|
Note
payable
|
|
|
123,228
|
|
|
151,970
|
|
Obligation
under capital lease
|
|
|
2,700,000
|
|
|
2,700,000
|
|
Deferred
income taxes payable
|
|
|
1,773,546
|
|
|
1,659,333
|
|
Other
liabilities
|
|
|
1,037,853
|
|
|
1,117,623
|
|
Unearned
revenue
|
|
|
81,021
|
|
|
100,438
|
|
Total
liabilities
|
|
|
42,971,570
|
|
|
39,832,606
|
|
Commitments
and contingencies
|
|
|
|
|
|
|
|
Stockholders’
equity:
|
|
|
|
|
|
|
|
Preferred
stock, $1.00 par value; authorized 250,000 shares; no shares
issued
|
|
|
—
|
|
|
—
|
|
Common
stock, $.02 par value; authorized 50,000,000 shares; issued 11,588,512
and
10,156,673 at September 30, 2007 and December 31, 2006,
respectively
|
|
|
231,771
|
|
|
203,134
|
|
Additional
paid-in capital
|
|
|
53,737,826
|
|
|
46,951,501
|
|
Accumulated
deficit
|
|
|
(20,666,695
|
)
|
|
(18,195,109
|
)
|
Accumulated
other comprehensive income
|
|
|
728,605
|
|
|
253,979
|
|
|
|
|
34,031,507
|
|
|
29,213,505
|
|
Treasury
stock at cost, 84,300 shares
|
|
|
(196,641
|
)
|
|
(196,641
|
)
|
Total
stockholders’ equity
|
|
|
33,834,866
|
|
|
29,016,864
|
|
Total
liabilities and stockholders’ equity
|
|
$
|
76,806,436
|
|
$
|
68,849,470
|
|
See
accompanying notes to unaudited condensed consolidated financial
statements.
LANGER,
INC. AND SUBSIDIARIES
Condensed
Consolidated Statements of Operations
(Unaudited)
|
|
Three months ended
|
|
Nine months ended
|
|
|
|
September
30,
|
|
September 30,
|
|
|
|
2007
|
|
2006
|
|
2007
|
|
2006
|
|
|
|
|
|
|
|
|
|
|
|
Net
sales
|
|
$
|
17,409,121
|
|
$
|
9,065,316
|
|
$
|
49,941,321
|
|
$
|
26,603,881
|
|
Cost
of sales
|
|
|
10,950,981
|
|
|
5,366,275
|
|
|
31,927,784
|
|
|
16,122,671
|
|
Gross
profit
|
|
|
6,458,140
|
|
|
3,699,041
|
|
|
18,013,537
|
|
|
10,481,210
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
General
and administrative expenses
|
|
|
3,847,948
|
|
|
2,492,513
|
|
|
10,823,379
|
|
|
7,188,018
|
|
Selling
expenses
|
|
|
2,592,442
|
|
|
1,566,668
|
|
|
7,405,377
|
|
|
5,089,335
|
|
Research
and development expenses
|
|
|
223,162
|
|
|
151,561
|
|
|
630,296
|
|
|
416,898
|
|
Operating
loss
|
|
|
(205,412
|
)
|
|
(511,701
|
)
|
|
(845,515
|
)
|
|
(2,213,041
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other
expense, net:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
income
|
|
|
23,479
|
|
|
152,291
|
|
|
230,683
|
|
|
522,332
|
|
Interest
expense
|
|
|
(557,334
|
)
|
|
(217,870
|
)
|
|
(1,632,973
|
)
|
|
(799,843
|
)
|
Other
|
|
|
4,309
|
|
|
3,436
|
|
|
(13,582
|
)
|
|
23,246
|
|
Other
expense, net
|
|
|
(529,546
|
)
|
|
(62,143
|
)
|
|
(1,415,872
|
)
|
|
(254,265
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss
before income taxes
|
|
|
(734,958
|
)
|
|
(573,844
|
)
|
|
(2,261,387
|
)
|
|
(2,467,306
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Provision
for (benefit from) income taxes
|
|
|
102,078
|
|
|
(20,615
|
)
|
|
210,199
|
|
|
(6,398
|
)
|
Net
loss
|
|
$
|
(837,036
|
)
|
$
|
(553,229
|
)
|
$
|
(2,471,586
|
)
|
$
|
(2,460,908
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
loss per common share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
and diluted
|
|
$
|
(.07
|
)
|
$
|
(.06
|
)
|
$
|
(.22
|
)
|
$
|
(.25
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
average number of common shares used in computation of net loss per
share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
and diluted
|
|
|
11,484,973
|
|
|
9,960,009
|
|
|
11,383,193
|
|
|
9,948,101
|
|
See
accompanying notes to unaudited condensed consolidated financial
statements.
LANGER,
INC. AND SUBSIDIARIES
Condensed
Consolidated Statements of Stockholders’ Equity
For
the nine months ended September 30, 2007
(Unaudited)
|
|
|
|
|
|
|
|
|
|
Accumulated
Other
Comprehensive
Income (Loss)
|
|
|
|
|
|
|
|
Common Stock
|
|
Treasury
|
|
Additional
Paid-in
|
|
Accumulated
|
|
Foreign
Currency
|
|
|
|
|
|
Total
Stockholder’s
|
|
|
|
Shares
|
|
Amount
|
|
Stock
|
|
Capital
|
|
Deficit
|
|
Translation
|
|
Costs
|
|
(Loss)
|
|
Equity
|
|
Balance
at January 1, 2007
|
|
|
10,156,673
|
|
$
|
203,134
|
|
$
|
(196,641
|
)
|
$
|
46,951,501
|
|
$
|
(18,195,109
|
)
|
$
|
397,450
|
|
$
|
(143,471
|
)
|
|
|
|
$
|
29,016,864
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
loss
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
(2,471,586
|
)
|
|
—
|
|
|
—
|
|
$
|
(2,471,586
|
)
|
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Change
in unrecognized periodic pension costs
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
143,471
|
|
|
|
|
|
143,471
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Foreign
currency adjustment
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
331,155
|
|
|
—
|
|
|
331,155
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
comprehensive loss
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
$
|
(2,140,431
|
)
|
|
(2,140,431
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock-based
compensation expense
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
219,347
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
|
|
|
219,347
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercise
of stock options
|
|
|
30,000
|
|
|
600
|
|
|
—
|
|
|
45,150
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
|
|
|
45,750
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Discount
on 5% convertible notes
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
476,873
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
|
|
|
476.873
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Issuance
of stock to purchase Regal
|
|
|
333,483
|
|
|
6,670
|
|
|
—
|
|
|
1,365,279
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
|
|
|
1,371,949
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Issuance
of stock to purchase Twincraft
|
|
|
999,375
|
|
|
19,987
|
|
|
—
|
|
|
4,377,263
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
|
|
|
4,397,250
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Adjustment
to issuance of stock to purchase Twincraft
|
|
|
68,981
|
|
|
1,380
|
|
|
—
|
|
|
302,413
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
|
|
|
303,793
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance
at September 30, 2007
|
|
|
11,588,512
|
|
$
|
231,771
|
|
$
|
(196,641
|
)
|
$
|
53,737,826
|
|
$
|
(20,666,695
|
)
|
|
728,605
|
|
$
|
—
|
|
|
|
|
$
|
33,834,866
|
|
See
accompanying notes to unaudited condensed consolidated financial
statements.
LANGER,
INC. AND SUBSIDIARIES
Condensed
Consolidated Statements of Cash Flows
(Unaudited)
|
|
Nine months ended
|
|
|
|
September
30,
|
|
|
|
2007
|
|
2006
|
|
Cash
Flows From Operating Activities:
|
|
|
|
|
|
Net
loss
|
|
$
|
(2,471,586
|
)
|
$
|
(2,460,908
|
)
|
Adjustments
to reconcile net loss to net cash provided by (used in) operating
activities:
|
|
|
|
|
|
|
|
Depreciation
of property and equipment and amortization of identifiable intangible
assets
|
|
|
2,889,102
|
|
|
1,315,547
|
|
Gain
on sale of disposition of property and equipment
|
|
|
—
|
|
|
(1,348
|
)
|
Loss
on abandonment of property and equipment
|
|
|
28,193
|
|
|
8,046
|
|
Amortization
of debt acquisition costs
|
|
|
231,389
|
|
|
127,853
|
|
Amortization
of debt discount
|
|
|
64,172
|
|
|
—
|
|
Stock-based
compensation expense
|
|
|
219,347
|
|
|
163,126
|
|
Provision
for doubtful accounts receivable
|
|
|
378,392
|
|
|
82,661
|
|
Provision
for pension
|
|
|
143,471
|
|
|
—
|
|
Deferred
income taxes
|
|
|
114,213
|
|
|
(75,532
|
)
|
Changes
in operating assets and liabilities, net of effects from
acquisitions:
|
|
|
|
|
|
|
|
Accounts
receivable
|
|
|
(2,085,999
|
)
|
|
(128,311
|
)
|
Inventories
|
|
|
(281,142
|
)
|
|
69,895
|
|
Prepaid
expenses and other current assets
|
|
|
(410,631
|
)
|
|
72,647
|
|
Other
assets
|
|
|
778,200
|
|
|
(43,540
|
)
|
Accounts
payable and other current liabilities
|
|
|
767,396
|
|
|
(144,505
|
)
|
Unearned
revenue and other liabilities
|
|
|
(158,545
|
)
|
|
152,545
|
|
Net
cash provided by (used in) operating activities
|
|
|
205,972
|
|
|
(861,824
|
)
|
|
|
|
|
|
|
|
|
Cash
Flows From Investing Activities:
|
|
|
|
|
|
|
|
Purchase
of property and equipment
|
|
|
(1,072,049
|
)
|
|
(850,953
|
)
|
Increase
in restricted cash - escrow
|
|
|
(1,000,000
|
)
|
|
—
|
|
Proceeds
from disposal of property and equipment
|
|
|
1,000
|
|
|
2,270
|
|
Purchase
of Twincraft, net of cash acquired
|
|
|
(25,901,387
|
)
|
|
—
|
|
Net
cash used in investing activities
|
|
|
(27,972,436
|
)
|
|
(848,683
|
)
|
|
|
|
|
|
|
|
|
Cash
Flows From Financing Activities:
|
|
|
|
|
|
|
|
Repayment
of note payable
|
|
|
(26,960
|
)
|
|
(8,527
|
)
|
Payment
of debt acquisition costs
|
|
|
(267,492
|
)
|
|
—
|
|
Repayment
of convertible notes
|
|
|
—
|
|
|
(14,439,000
|
)
|
Proceeds
from the exercise of stock options
|
|
|
45,750
|
|
|
45,750
|
|
Proceeds
from the exercise of warrants
|
|
|
—
|
|
|
500
|
|
Net
cash used in financing activities
|
|
|
(248,702
|
)
|
|
(14,401,277
|
)
|
Effect
of exchange rate changes on cash
|
|
|
69,174
|
|
|
54,865
|
|
Net
decrease in cash and cash equivalents
|
|
|
(27,945,992
|
)
|
|
(16,056,919
|
)
|
Cash
and cash equivalents at beginning of period
|
|
|
29,766,997
|
|
|
18,828,989
|
|
Cash
and cash equivalents at end of period
|
|
$
|
1,821,005
|
|
$
|
2,772,070
|
|
|
|
Nine
months ended
|
|
|
|
September 30,
|
|
|
|
2007
|
|
2006
|
|
Supplemental
Disclosures of Non-Cash Investing Activities:
|
|
|
|
|
|
Issuance
of stock for two acquisitions
|
|
$
|
6,072,992
|
|
|
|
|
Accounts
payable and accrued liabilities relating to property and
equipment
|
|
$
|
40,349
|
|
$
|
566,237
|
|
Increase
in accrued liabilities due to investing activities
|
|
|
|
|
$
|
166,893
|
|
|
|
|
|
|
|
|
|
Supplemental
Disclosures of Non-Cash Financing Activities:
|
|
|
|
|
|
|
|
Leasehold
improvements funded by landlord accounted for as deferred
credit
|
|
|
|
|
$
|
606,960
|
|
Issuance
of note payable to fund leasehold improvements
|
|
|
|
|
$
|
202,320
|
|
See
accompanying notes to unaudited condensed consolidated financial
statements.
LANGER,
INC. AND SUBSIDIARIES
Notes
To Unaudited Condensed Consolidated Financial Statements
NOTE
1 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND OTHER
MATTERS
(a)
Basis of Presentation
The
accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q and Article 10-01
of Regulation S-X. Accordingly, they do not include all of the information
and
footnotes required by accounting principles generally accepted in the United
States of America for complete financial statements. In the opinion of
management, all adjustments (consisting of normal recurring accruals) considered
necessary for a fair presentation have been included. These unaudited condensed
consolidated financial statements should be read in conjunction with the related
financial statements and consolidated notes included in the Company’s annual
report on Form 10-K for the fiscal year ended December 31, 2006.
Operating
results for the three and nine months ended September 30, 2007 are not
necessarily indicative of the results that may be expected for the year ending
December 31, 2007. During the three months ended March 31, 2007, the Company
consummated two acquisitions which are included in the Company’s financial
statements for this period (see Note 2, "Acquisitions").
(b)
Restricted Cash
Restricted
cash consists of $1,000,000, which is being held in escrow relating to the
Company’s acquisition of Twincraft, Inc. (“Twincraft”). The escrow will be
released on July 23, 2008 (18 months after the closing), net of any claims
against the escrow plus any accrued interest.
(c)
Provision for Income Taxes
For
the
three and nine months ended September 30, 2007, the Company’s provision for
income taxes on foreign operations was approximately $38,000 and approximately
$57,000, respectively. For the three and nine months ended September 30, 2006,
the Company’s provision for income taxes on foreign operations was approximately
$4,000 and $70,000, respectively.
In
June
2006, the Financial Accounting Standards Board (“FASB”) issued Interpretation
No. 48, “Accounting for Uncertainty in Income Taxes,” (“FIN 48”), an
interpretation of Statement of Financial Accounting Standards (“SFAS”) No. 109,
“Accounting for Income Taxes.” FIN 48 clarifies the accounting for income
taxes by prescribing a minimum recognition threshold that a tax position is
required to meet before being recognized in the financial statements.
FIN 48 also provides guidance on derecognition, measurement,
classification, interest and penalties, accounting in interim periods,
disclosure and transition. FIN 48 is effective for fiscal years beginning
after December 15, 2006.
The
Company adopted FIN 48 on January 1, 2007. Under FIN 48, tax benefits are
recognized only for tax positions that are more likely than not to be sustained
upon examination by tax authorities. The amount recognized is measured as the
largest amount of benefit that is greater than 50 percent likely to be realized
upon ultimate settlement. Unrecognized tax benefits are tax benefits claimed
or
to be claimed in tax returns that do not meet these measurement standards.
The
Company’s adoption of FIN 48 did not have a material effect on the Company's
financial statements, and the Company does not expect the adoption of FIN 48
to
have a significant impact on its results of operations or financial position
for
the year ending December 31, 2007.
As
permitted by FIN 48, the Company also adopted an accounting policy to
prospectively classify accrued interest and penalties related to any
unrecognized tax benefits in its income tax provision. Previously, the Company's
policy was to classify interest and penalties as an operating expense in
arriving at pre-tax income. At September 30, 2007, the Company does not have
accrued interest and penalties related to any unrecognized tax benefits. The
years subject to potential audit vary depending on the tax jurisdiction.
Generally, the Company's statutes of limitation for tax liabilities are open
for
tax years ended December 31, 2003 and forward. The Company's major taxing
jurisdictions include the United States, Canada, and the United Kingdom. Within
the United States, both Vermont and New York could give rise to significant
tax
liabilities.
(d)
Reclassifications
Certain
amounts have been reclassified in the prior period consolidated financial
statements to present them on a basis consistent with the current
periods.
(e)
Seasonality
Revenue
derived from sales of medical devices in North America has historically been
significantly higher in the warmer months of the year, while sales of medical
devices by the United Kingdom subsidiary have historically not evidenced any
seasonality. Personal care product revenues relating to the health and beauty
aid segment fluctuates during the year, due to an increase in seasonal demand
during the second and fourth quarters.
(f)
Stock-Based
Compensation
Effective
January 1, 2006, the Company adopted SFAS No. 123(R), “Share-Based Payment.”
SFAS No. 123(R) replaces SFAS No. 123 and supersedes Accounting Principles
Board
Opinion No. 25. SFAS No. 123(R) requires that all employee stock-based
compensation be recognized as an expense in the financial statements and that
such costs be measured at the fair value of the awards. The total employee
stock
compensation expense included in general and administrative expenses for the
three and nine months ended September 30, 2007 was $52,116 and $167,422,
respectively, and for the three and nine months ended September 30, 2006 was
$75,466 and $176,168 respectively.
For
the
three months ended March 31, 2007, the Company granted 425,000 options under
the
Company’s 2005 Stock Incentive Plan (the “2005 Plan”). These options were
granted to employees of Twincraft at an exercise price of $4.20. A total of
325,000 options were awarded to employees and 100,000 options were awarded
to a
non-employee.
The
Company accounts for equity issuances to non-employees in accordance with
Emerging Issues Task Force (“EITF”) Issue No. 96-18, “Accounting for Equity
Instruments that are Issued to Other Than Employees for Acquiring, or in
Conjunction with Selling, Goods and Services.” All transactions in which goods
or services are the consideration received for the issuance of equity
instruments are accounted for based on the fair value of the consideration
received or the fair value of the equity instrument issued, whichever is more
reliably measurable. The fair value of the option issued is used to measure
the
transaction, as this is more reliable than the fair market value of the services
received. The Company utilizes the Black-Scholes option pricing model to
determine the fair value at the end of each reporting period. Non-employee
stock-based compensation expense is subject to periodic adjustment and is being
recognized over the vesting periods of the related options. The fair value
of
the equity instrument is charged directly to compensation expense and additional
paid-in-capital. During the three months ended March 31, 2007, the Company
issued 100,000 stock options in conjunction with a non-employee consulting
agreement with Fifth Element, LLC. For the three and nine months ended September
30, 2007, $22,884 and $51,924, respectively, was recorded as consulting
expense.
Restricted
Stock
During
the nine months ended September 30, 2007, the Company has entered into various
restricted stock awards which under SFAS No. 123(R) are classified as
performance based awards in which the specific performance condition or
contingency must be satisfied in order for the awards to vest, and the Company
will recognize compensation expense when the achievement of the performance
condition is probable.
On
January 23, 2007, the Company entered into restricted stock award agreements
with members of the Board of Directors and a non-Board executive in the amount
of 805,000 shares and 75,000 shares, respectively, under the Company’s 2005
Plan. Under the terms of the restricted stock award agreements, the shares
are
not presently vested and will vest in the event of change of control of the
Company or when the Company achieves EBITDA (excluding non-recurring events
at
the discretion of the Company’s Board of Directors) in aggregate of $10,000,000
in any four consecutive calendar quarters, starting with the quarter beginning
January 1, 2007. In the event the Company divests a business unit, EBITDA for
any such period of four quarters which includes the date of the divestiture
shall be the greater of (i) actual EBITDA for the relevant four quarters, and
(ii) the net sum of the actual EBITDA for the relevant four quarters, minus
(a)
EBITDA attributable to the divested portion of the business, plus (b) an amount
equal to 20% of the purchase price paid to Langer in the
divestiture.
On
September 4, 2007, the Company entered into a restricted stock award agreement
with a non-Board executive of the Company for 75,000 shares under the Company’s
2007 Stock Incentive Plan. Under the terms of the restricted stock award
agreement, the shares are not presently vested and will vest when a) the Company
achieves EBITDA (excluding non-recurring events at the discretion of the
Company’s Board of Directors) in aggregate of $25,000,000 in any four
consecutive calendar quarters, starting with the quarter beginning October
1,
2007, and b) the fair market value of the Company’s stock is not less than
$15.00 for five trading days in any period of ten consecutive trading
days.
As
of
September 30, 2007, the Company has not recognized compensation expense related
to the restricted stock awards, nor are the awards considered outstanding in
the
computation of basic earnings per share.
(g)
Recently
Issued Accounting Pronouncements
On
September 15, 2006, the FASB issued SFAS No. 157, “Fair Value Measurements.”
SFAS No. 157 is effective for fiscal years beginning after November 15, 2007,
and interim periods within those fiscal years. SFAS No. 157 provides guidance
related to estimating fair value and requires expanded disclosures. The standard
applies whenever other standards require (or permit) assets or liabilities
to be
measured at fair value. The standard does not expand the use of fair value
in
any new circumstances. The Company is evaluating SFAS No. 157 and its impact
on
the Company’s consolidated financial statements, but it is not expected to have
a significant impact.
On
February 22, 2007, the FASB issued SFAS No. 159, "The Fair Value Option for
Financial Assets and Financial Liabilities." This statement gives entities
the
option to carry most financial assets and liabilities at fair value, with
changes in fair value recorded in earnings. This statement, which will be
effective in the first quarter of fiscal 2009, is not expected to have a
material impact on the Company’s consolidated financial position or results of
operations. The Company is evaluating whether to adopt this
statement.
NOTE
2
—
ACQUISITIONS
(a)
Acquisition
of Regal Medical Supply, LLC
On
January 8, 2007, the Company acquired certain assets of Regal Medical Supply,
LLC (“Regal”), which is a provider of contracture management products and
services to the long-term care market of skilled nursing and assisted living
facilities in 22 states. Regal was acquired in an effort to gain access to
the
long term care market, to gain a captive distribution channel for certain custom
products the Company manufactures into markets the Company has not previously
penetrated, and to establish a national network of service professionals to
enhance its customer relationships in both its core and new markets. The results
of operations of Regal since January 8, 2007 (the date of acquisition) have
been
included in the Company’s consolidated financial statements as part of the
medical products operating segment.
The
initial consideration for the acquisition of the assets of Regal (before
post-closing adjustments) was approximately $1,640,000, which was paid through
the issuance of 379,167 shares of the Company’s common stock valued under the
asset purchase agreement at a price of $4.329. In addition, transaction costs
in
the amount of $69,721 were incurred, which increased the purchase price to
$1,709,721. The purchase price was subject to a post-closing downward adjustment
to the extent that the working capital as reflected on Regal’s January 8, 2007
(closing date) balance sheet was less than $675,000. On March 12, 2007, the
Company and Regal agreed to a post-closing downward adjustment, pursuant to
terms of the asset purchase agreement, reducing the price from $1,709,721 to
$1,441,670, which was effected by the cancellation of 45,684 shares, which
were
valued for purposes of the adjustment at $4.114, which was the average closing
price of the Company’s common stock on The NASDAQ Global Market (“NASDAQ”) for
the 5 trading days ended December 19, 2006. In the three months ended September
30, 2007, the Company reclassified certain assets of $418,253, which represents
amounts to be paid to the Company by the selling shareholders resulting from
receivables acquired but not collected pursuant to the terms of the asset
purchase agreement, and is now the subject of a claim by the Company against
the
selling shareholders pursuant to the asset purchase agreement. The return of
the
purchase price consideration may be settled in the form of cash or the return
of
shares. The Company entered into a three-year employment agreement with a former
employee of the seller and a non-competition agreement with the seller and
seller’s members.
The
following table sets forth the components of the purchase price:
Total
stock consideration
|
|
$
|
1,371,949
|
|
Transaction
costs
|
|
|
69,721
|
|
Total
purchase price
|
|
$
|
1,441,670
|
|
The
following table provides the preliminary allocation of the purchase price based
upon the fair value of the assets acquired and liabilities assumed at January
8,
2007:
Assets:
|
|
|
|
Accounts
receivable
|
|
$
|
387,409
|
|
Amounts
receivable from seller
|
|
|
418,253
|
|
Property
and equipment
|
|
|
25,030
|
|
Goodwill
|
|
|
959,268
|
|
|
|
|
1,789,960
|
|
Liabilities:
|
|
|
|
|
Accounts
payable
|
|
|
275,206
|
|
Accrued
liabilities
|
|
|
73,084
|
|
|
|
|
348,290
|
|
Total
purchase price
|
|
$
|
1,441,670
|
|
In
accordance with the provisions of SFAS No. 142, “Goodwill and Other
Intangible Assets,” the Company will not amortize goodwill.
(b)
Acquisition
of Twincraft
On
January 23, 2007, the Company completed the acquisition of all of the
outstanding stock of Twincraft. Twincraft is a leading private label
manufacturer of specialty bar soaps supplying the health and beauty markets,
mass markets and direct marketing channels and operates out of a manufacturing
facility in Winooski, Vermont. Twincraft was acquired to expand into additional
product categories in the personal care market, to increase the Company’s
customer exposure for its current line of Silipos gel-based skincare products,
and to take advantage of potential commonalities in research and development
advances between Twincraft’s and the Company’s current product lines. The
purchase price for Twincraft was determined by arm’s length negotiations between
the Company and the former stockholders of Twincraft and was based in part
upon
analyses and due diligence, which the Company performed on the financial records
of the former stockholders of Twincraft, focusing on enterprise value, historic
cash flows and expected future cash flows to determine valuation. The results
of
operations of Twincraft since January 23, 2007 (the date of acquisition) have
been included in the Company’s consolidated financial statements as part of the
personal care products operating segment.
The
purchase price paid for Twincraft at the time of closing was approximately
$26,650,000, of which $1,500,000 was held in two separate escrows to partially
secure payment of any indemnification claims, and payment for any purchase
price
adjustments and/or working capital adjustments based on the final post-closing
audit. On May 30, 2007, the escrow of $500,000 was released to the sellers
of
Twincraft. The remaining escrow of $1,000,000 will not be released until 18
months after the closing, net of any claims which the Company has against the
escrow. This portion of the escrow is considered to be contingent consideration
and not part of the purchase price and is classified as restricted cash on
the
Company’s consolidated balance sheet. The purchase price was paid 85% in cash
and the balance through the issuance of the Company’s common stock to the
sellers of Twincraft, which was valued based on the closing price of the
Company’s common stock on the two days before, two days after, and on November
14, 2006, which was the date the Company and Twincraft’s stockholders entered
into the purchase agreement. The purchase price is subject to adjustment based
on Twincraft’s working capital target of $5,100,000 at closing, and operating
performance for the year ended December 31, 2006. On May 15, 2007,
the working capital adjustment, which was agreed to by the Company and the
sellers of Twincraft, in effect increased the purchase price of the Twincraft
acquisition by approximately $1,276,000 payable in cash. In addition, on May
15,
2007, the operating performance adjustments, which were agreed to by
the Company and the sellers of Twincraft, increased the purchase
price of Twincraft by approximately $1,867,000, and the adjustments were made
by
the issuance of 68,981 shares of the Company’s common stock (representing 15% of
the adjustment to the purchase consideration) and the balance of approximately
$1,564,000 was paid in cash. The cash adjustment for working capital and
operating performance totaling approximately $2,840,000 was paid to the sellers
in the three months ended June 30, 2007. During the three months ended June
30,
2007, approximately $193,000 of additional transaction costs relating to the
Twincraft acquisition was incurred, resulting in an increase to the cost of
the
Twincraft acquisition, and is reflected in goodwill.
Effective
January 23, 2007, Twincraft entered into three-year employment agreements
with Peter A. Asch, who will serve as President of Twincraft, and A. Lawrence
Litke, who will serve as Chief Operating Officer of Twincraft. The Company
also
entered into a consulting agreement with Fifth Element, LLC, a consulting firm
controlled by Joseph Candido, who will serve as Vice President of Sales and
Marketing for Twincraft. The employment agreements of Mr. Asch and Mr. Litke,
and the consulting agreement of Fifth Element, LLC, contain non-competition
and
non-solicitation provisions covering the terms of their agreements and for
any
extended severance periods and for one year after termination of the agreements
or the extended severance periods, if any. Messrs. Asch, Litke and Candido
were
stockholders of Twincraft immediately before the sale of Twincraft to the
Company.
Subject
to the terms and conditions set forth in the Twincraft purchase agreement,
the
sellers of Twincraft (including Mr. Asch) can earn additional deferred
consideration for the years ended 2007 and 2008. Deferred consideration would
be
earned for the year ending December 31, 2007 if Twincraft’s adjusted EBITDA
exceeds its 2006 adjusted EBITDA; the Company will pay to the Sellers the
increase multiplied by a factor of three. The sellers of Twincraft can also
earn
deferred consideration for the year ending December 31, 2008, if its 2008
adjusted EBITDA exceeds its 2007 EBITDA; the Company will pay to the Sellers
the
increase multiplied by a factor of three.
On
January 23, 2007, as part of their employment agreements, the Company granted
stock options of 200,000 and 100,000 shares, respectively, to Messrs. Asch
and
Litke, all under the Company’s 2005 Plan, to purchase shares of the Company’s
common stock having an exercise price equal to $4.20 per share, which vest
in
three equal consecutive annual tranches beginning on January 23, 2009. The
Company also granted a stock option, on January 23, 2007, to Mr. Mark Davitt,
another Twincraft employee, for 25,000 shares with an exercise price of $4.20
per share, vesting in three equal consecutive annual tranches commencing on
the
first anniversary of the grant date. The Company is recognizing stock
compensation expenses related to these options over the requisite service period
in accordance with SFAS No. 123(R). Pursuant to EITF No. 96-18, the Company
recorded consulting expenses relating to 100,000 stock options granted to Fifth
Element, LLC, a non-employee consultant, which is controlled by Mr. Joseph
Candido, a Twincraft officer and one of the former Twincraft
stockholders.
The
following table sets forth the components of the purchase price:
Total
cash consideration (including $1,500,000 escrow)
|
|
$
|
24,492,639
|
|
Total
stock consideration
|
|
|
4,701,043
|
|
Transaction
costs
|
|
|
1,445,714
|
|
Total
purchase price
|
|
$
|
30,639,396
|
|
The
following table provides the preliminary allocation of the purchase price based
upon the fair value of the assets acquired and liabilities assumed at January
23, 2007 and is based upon a third-party appraisal:
Assets:
|
|
|
|
Cash
and cash equivalents
|
|
$
|
36,966
|
|
Accounts
receivable
|
|
|
3,984,756
|
|
Inventories
|
|
|
4,200,867
|
|
Other
current assets
|
|
|
127,911
|
|
Property
and equipment
|
|
|
7,722,140
|
|
Goodwill
|
|
|
7,022,425
|
|
Identifiable
intangible assets (trade names of $2,629,300 and repeat customer base
of $7,214,500)
|
|
|
9,843,800
|
|
|
|
|
32,938,865
|
|
Liabilities:
|
|
|
|
|
Accounts
payable
|
|
|
517,929
|
|
Accrued
liabilities
|
|
|
1,781,540
|
|
|
|
|
2,299,469
|
|
Total
purchase price
|
|
$
|
30,639,396
|
|
In
accordance with the provisions of SFAS No. 142, the Company will not
amortize goodwill. The intangible assets are deemed to have definite lives
and
will be amortized over an appropriate period that matches the economic benefit
of the intangible assets. The trade names will be amortized over a 23 year
period and the repeat customer base over a 19 year period. The value allocated
to goodwill and identifiable intangible assets in the purchase of Twincraft
are
not deductible for income tax purposes.
(c)
Unaudited Pro Forma Results
Below
are
the unaudited pro forma results of operations for the three and nine months
ended September 30, 2007 and 2006, as if the Company had acquired Regal and
Twincraft on January 1, 2006. Such pro forma results are not necessarily
indicative of the actual consolidated results of operations that would have
been
achieved if the acquisition occurred on the date assumed, nor are they
necessarily indicative of future consolidated results of
operations.
Unaudited
pro forma results for the three and nine months ended September 30, 2007 and
2006 were:
|
|
Three months ended
September 30,
|
|
Nine months ended
September 30,
|
|
|
|
2007
|
|
2006
|
|
2007
|
|
2006
|
|
Net
sales
|
|
$
|
17,409,121
|
|
$
|
16,731,895
|
|
$
|
51,876,510
|
|
$
|
49,510,092
|
|
Net
(loss) income
|
|
|
(837,036
|
)
|
|
300,208
|
|
|
(2,367,769
|
)
|
|
(833,674
|
)
|
(Loss)
income per share - basic and diluted
|
|
|
(.07
|
)
|
|
.03
|
|
|
(.21
|
)
|
|
(.07
|
)
|
NOTE
3 — IDENTIFIABLE INTANGIBLE ASSETS
Identifiable
intangible assets at September 30, 2007 consisted of:
Assets
|
|
|
Estimated
Useful Life
|
|
|
Adjusted
Cost
|
|
|
Accumulated
Amortization
|
|
|
Net Carrying
Value
|
|
Non-competition
agreements—Benefoot/Bi-Op
|
|
|
4
Years
|
|
$
|
572,000
|
|
$
|
410,960
|
|
$
|
161,040
|
|
License
agreements and related technology—Benefoot
|
|
|
5
to 8 Years
|
|
|
1,156,000
|
|
|
735,097
|
|
|
420,903
|
|
Repeat
customer base—Bi-Op
|
|
|
7
Years
|
|
|
500,000
|
|
|
185,186
|
|
|
314,814
|
|
Trade
names—Silipos
|
|
|
Indefinite
|
|
|
2,688,000
|
|
|
—
|
|
|
2,688,000
|
|
Repeat
customer base—Silipos
|
|
|
7
Years
|
|
|
1,680,000
|
|
|
720,000
|
|
|
960,000
|
|
License
agreements and related technology—Silipos
|
|
|
9.5
Years
|
|
|
1,364,000
|
|
|
430,738
|
|
|
933,262
|
|
Repeat
customer base—Twincraft
|
|
|
19
Years
|
|
|
7,214,500
|
|
|
359,331
|
|
|
6,855,169
|
|
Trade
names—Twincraft
|
|
|
23
Years
|
|
|
2,629,300
|
|
|
76,212
|
|
|
2,553,088
|
|
|
|
|
|
|
$
|
17,803,800
|
|
$
|
2,917,524
|
|
$
|
14,886,276
|
|
Identifiable
intangible assets at December 31, 2006 consisted of:
|
|
|
Estimated
Useful Life
|
|
|
Adjusted
Cost
|
|
|
Accumulated
Amortization
|
|
|
Net Carrying
Value
|
|
Non-competition
agreements—Benefoot/Bi-Op
|
|
|
4
Years
|
|
$
|
572,000
|
|
$
|
350,570
|
|
$
|
221,430
|
|
License
agreements and related technology—Benefoot
|
|
|
5
to 8 Years
|
|
|
1,156,000
|
|
|
647,824
|
|
|
508,176
|
|
Repeat
customer base— Bi-Op
|
|
|
7
Years
|
|
|
500,000
|
|
|
137,963
|
|
|
362,037
|
|
Trade
names—Silipos
|
|
|
Indefinite
|
|
|
2,688,000
|
|
|
—
|
|
|
2,688,000
|
|
Repeat
customer base—Silipos
|
|
|
7
Years
|
|
|
1,680,000
|
|
|
540,000
|
|
|
1,140,000
|
|
License
agreements and related technology—Silipos
|
|
|
9.5
Years
|
|
|
1,364,000
|
|
|
323,053
|
|
|
1,040,947
|
|
|
|
|
|
|
$
|
7,960,000
|
|
$
|
1,999,410
|
|
$
|
5,960,590
|
|
Aggregate
amortization expense relating to the above identifiable intangible assets for
the three months ended September 30, 2007 and 2006 was $324,186 and $160,857,
respectively, and for the nine month periods then ended, was $918,114 and
$482,568, respectively. As of September 30, 2007, the estimated future
amortization expense is $322,800 for 2007, $1,347,717 for 2008, $1,342,221
for
2009, $1,269,761 for 2010, $1,182,381 for 2011, and $6,733,396
thereafter.
NOTE
4
— GOODWILL
Changes
in goodwill for the nine months ended September 30, 2007 are as
follows:
|
|
Medical
Products
|
|
Personal
Care
Products
|
|
Total
|
|
Balance,
December 31, 2006
|
|
$
|
11,293,494
|
|
$
|
2,825,719
|
|
$
|
14,119,213
|
|
Allocated
goodwill related to the Regal Medical Supply, LLC acquisition (See
Note
2(a))
|
|
|
1,026,800
|
|
|
—
|
|
|
1,026,800
|
|
Allocated
goodwill related to the Twincraft acquisition (See Note
2(b))
|
|
|
—
|
|
|
6,829,530
|
|
|
6,829,530
|
|
Balance,
March 31, 2007
|
|
|
12,320,294
|
|
|
9,655,249
|
|
|
21,975,543
|
|
Additional
transaction costs related to Twincraft (See Note 2(b))
|
|
|
—
|
|
|
192,895
|
|
|
192,895
|
|
Balance,
June 30, 2007
|
|
|
12,320,294
|
|
|
9,848,144
|
|
|
22,168,438
|
|
Net
adjustment to goodwill related to Regal Medical Supply, LLC, due
to
revised fair value of inventory and receivables
|
|
|
(67,532
|
)
|
|
—
|
|
|
(67,532
|
)
|
Balance,
September 30, 2007
|
|
$
|
12,252,762
|
|
$
|
9,848,144
|
|
$
|
22,100,906
|
|
NOTE
5 — INVENTORIES, NET
Inventories,
net, consisted of the following:
|
|
September
30,
2007
|
|
December 31,
2006
|
|
Raw
materials
|
|
$
|
4,868,552
|
|
$
|
2,318,201
|
|
Work-in-process
|
|
|
535,578
|
|
|
173,822
|
|
Finished
goods
|
|
|
3,287,657
|
|
|
1,668,241
|
|
|
|
|
8,691,787
|
|
|
4,160,264
|
|
Less:
Allowance for excess and obsolescence
|
|
|
837,862
|
|
|
885,151
|
|
|
|
$
|
7,853,925
|
|
$
|
3,275,113
|
|
NOTE
6 — CREDIT FACILITY
On
May 11, 2007, the Company entered into a secured revolving credit facility
agreement (the “Credit Facility”) with Wachovia Bank, N.A. expiring on September
30, 2011. The Credit Facility provides an aggregate maximum availability, if
and
when the Company has the requisite levels of assets,
in
the
amount of $20 million, and is subject to a sub-limit of $5 million for the
issuance of letter of credit obligations, another sub-limit of $5 million for
term loans, and a sub-limit of $7.5 million on loans against inventory. The
Credit Facility is collateralized by a first priority interest in inventory,
accounts receivables and all other assets and is guaranteed on a full and
unconditional basis by the Company, and each of the Company’s domestic
subsidiaries (Silipos, Twincraft and Regal) and any other company or person
that
hereafter becomes a borrower or owner of any property in which the lender has
a
security interest under the Credit Facility.
If
the
Company’s availability under the Credit Facility drops below $3 million or
borrowings under the facility exceed $10 million, the Company is required under
the Credit Facility to deposit all cash received from customers into a blocked
bank account that will be swept daily to directly pay down any loan outstanding
under the Credit facility. The Company would not have any control over the
blocked bank account.
The
Company’s borrowings availabilities are limited to 85% of eligible accounts
receivable and 60% of eligible inventory, and are subject to the satisfaction
of
certain conditions. Term loans shall be secured by equipment or real estate
hereafter acquired. The Company is required to submit monthly unaudited
financial statements to the lender beginning with the month ended September
30,
2007.
If
excess
availability is less than $3,000,000, the Credit Facility requires compliance
with various covenants including but not limited to a Fixed Charge Coverage
Ratio of not less than 1.0 to 1.0. As of September 30, 2007, the Company had
not
made draws on the Credit Facility and has approximately $6.1 million available
under the Credit Facility. Availability under the Credit Facility is reduced
by
40% of the outstanding letters of credit related to the purchase of eligible
inventory, as defined, and 100% of all other outstanding letters of credit.
At
September 30, 2007, the Company had outstanding letters of credit related to
the
purchase of eligible inventory of approximately $745,000, and other outstanding
letters of credit of approximately $571,000.
The
Company is required to pay monthly interest in arrears at the lender’s prime
rate or, at the Company’s election, at 2 percentage points above an Adjusted
Eurodollar Rate, as defined. To the extent that amounts under the Credit
Facility remain unused, while the Credit Facility is in effect and for so long
thereafter as any of the obligations under the Credit Facility are outstanding,
the Company will pay a monthly commitment fee of one-quarter of one percent
on
the unused portion of the loan commitment. The Company paid the lender a closing
fee in the amount of $75,000 in August 2007. As of September 30, 2007, the
Company has recorded deferred financing costs in connection with the Credit
Facility of $394,556, of which $23,459 and $34,876 has been amortized during
the
three and nine months ended September 30, 2007, respectively, and the balance
will be amortized over the life of the Credit Facility.
NOTE
7 — LONG-TERM DEBT, INCLUDING CURRENT INSTALLMENTS
On
December 8, 2006, the Company entered into a note purchase agreement for the
sale of $28,880,000 of 5% convertible subordinated notes due December 7, 2011
(the “5% Convertible Notes”). The 5% Convertible Notes are not registered under
the Securities Act of 1933, as amended. The Company has agreed to register
the
shares of the Company’s common stock acquirable upon conversion of the 5%
Convertible Notes, which may include an additional number of shares of common
stock issuable on account of adjustments of the conversion price under the
5%
Convertible Notes. The Company filed a registration statement with respect
to
the shares acquirable upon conversion of the 5% Convertible Notes (the
“Underlying Shares”) on January 9, 2007, and expects to file Amendment No.
1 thereof in November 2007. The registration statement has not been
declared effective.
The
5%
Convertible Notes bear interest at the rate of 5% per annum, payable in cash
semiannually on June 30 and December 31 of each year, commencing June 30, 2007.
For the three and nine months ended September 30, 2007, the Company recorded
interest expense relating to the 5% Convertible Notes of approximately $361,000
and approximately $1,082,000, respectively.
At
the
date of issuance, the 5% Convertible Notes were convertible at the rate of
$4.75
per share, subject to an adjustment for certain anti-dilution provisions. At
the
original conversion price at December 31, 2006, the number of Underlying Shares
was 6,080,000. Since the conversion price was above the market price on the
date
of issuance, there was no beneficial conversion. On January 8, 2007 and January
23, 2007, in conjunction with common stock issuances related to two acquisitions
(see Note 2, “Acquisitions”), the conversion price was adjusted to $4.6706, and
the number of Underlying Shares was thereby increased to 6,183,359, pursuant
to
the anti-dilution provisions applicable to the 5% Convertible Notes. On May
15,
2007 as a result of the issuance of an additional 68,981 shares of common stock
to the Twincraft sellers on account of upward adjustments to the Twincraft
purchase price, and the surrender to the Company of 45,684 shares of common
stock by Regal Medical Supply, LLC, on account of downward adjustments in the
Regal purchase price, the conversion price under the 5% Convertible Notes was
reduced to $4.6617, and the number of Underlying Shares was increased to
6,195,165 shares. This resulted in a debt discount of $476,873, which is
amortized over the term of the 5% Convertible Notes and is recorded as interest
expense in the consolidated statements of operations. The charge to interest
expense relating to the debt discount for the three and nine months ended
September 30, 2007 was approximately $22,000 and approximately $64,000,
respectively. The principal of the 5% Convertible Notes is due on December
7,
2011, subject to the earlier call of the 5% Convertible Notes by the Company,
as
follows: (i) the 5% Convertible Notes may not be called prior to December 7,
2007; (ii) from December 7, 2007, through December 7, 2009, the 5% Convertible
Notes may be called and redeemed for cash, in the amount of 105% of the
principal amount of the 5% Convertible Notes (plus accrued but unpaid interest,
if any, through the call date); (iii) after December 7, 2009, the 5% Convertible
Notes may be called and redeemed for cash in the amount of 100% of the principal
amount of the 5% Convertible Notes (plus accrued but unpaid interest, if any,
through the call date); and (iv) at any time after December 7, 2007, if the
closing price of the common stock of the Company on the NASDAQ (or any other
exchange on which the Company’s common stock is then traded or quoted) has been
equal to or greater than $7.00 per share for 20 of the preceding 30 trading
days
immediately prior to the Company’s issuing a call notice, then the 5%
Convertible Notes shall be mandatorily converted into common stock at the
conversion price then applicable. The Company held a Special Meeting of
Stockholders on April 19, 2007, at which the Company’s stockholders approved the
issuance by the Company of the Underlying Shares.
In
the event of a default on the 5% Convertible Notes, the due date of the 5%
Convertible Notes may be accelerated if demanded by holders of at least 40%
of
the 5% Convertible Notes, subject to a waiver by holders of at least 51% of
the
5% Convertible Notes if the Company pays all arrearages of interest on the
5%
Convertible Notes.
The
payment of interest and principal of the 5% Convertible Notes is subordinate
to
the Company’s presently existing capital lease obligation, in the amount of
$2,700,000, excluding current installments, as of September 30, 2007, and the
Company’s obligations under the Credit Facility. The 5% Convertible Notes would
also be subordinated to any additional debt which the Company may incur
hereafter for borrowed money, or under additional capital lease obligations,
obligations under letters of credit, bankers’ acceptances or similar credit
transactions (see Note 6, “Credit Facility”).
In
connection with the sale of the 5% Convertible Notes, the Company paid a
commission of $1,060,000 based on a rate of 4% of the amount of 5% Convertible
Notes sold, excluding the 5% Convertible Notes sold to members of the Board
of
Directors and their affiliates, to Wm Smith & Co., who served as placement
agent in the sale of the 5% Convertible Notes. The total cost of raising these
proceeds was $1,338,018, which will be amortized through December 7, 2011,
the
due date for the payment on the 5% Convertible Notes. The amortization of these
costs for the three and nine months ended September 30, 2007 was $66,779 and
$196,513, respectively, and is recorded as interest expense in the consolidated
statements of operations.
On
October 31, 2001, the Company completed the sale in a private placement, of
$14,589,000 principal amount of its 4% convertible subordinated notes due and
paid in full, plus accrued interest, on August 31, 2006 (the “4% Convertible
Notes”). The cost of raising these proceeds was $920,933, which was amortized
through August 31, 2006. The amortization of these costs for the three and
nine
months ended September 30, 2006 was $31,963 and $127,853, respectively, and
were
included in interest expense in the consolidated statements of operations.
Interest expense on the 4% Convertible Notes for the three and nine months
ended
September 30, 2006 was $96,260 and $385,040, respectively.
NOTE
8
— RESTRUCTURING
On
May 3,
2007, the Company announced its plan to close its Anaheim manufacturing facility
in order to better leverage the Company’s resources by reducing costs, obtaining
operational efficiencies and to further align the Company’s business with market
conditions, future revenue expectations and planned future product directions.
The plan included the elimination of 27 positions, which represented
approximately 4.5% of the Company’s workforce. During the three months ended
June 30, 2007, the Company recognized expenses of $200,485, consisting of
employee termination benefits and related costs of $128,572, loss on the
abandonment of fixed assets of $28,193, expenses relating to the exiting of
our
Anaheim leased facility, which would have expired in December 2007, of $34,560,
and other exit costs of $9,160. These plans are expected to be completed by
the
end of 2007.
NOTE
9
— SEGMENT INFORMATION
The
Company operates in two segments, medical products and personal care. Prior
to
January 1, 2007, the medical products segment was called the orthopedic segment
and the personal care segment was called the skincare segment. As discussed
in
Note 2, “Acquisitions,” the Company consummated two acquisitions in January
2007. The operations from the Twincraft acquisition are included in the personal
care segment, and the operations from the Regal acquisition are included in
the
medical products segment. The medical products segment includes the orthopedic
products of Silipos. Intersegment net sales are recorded at cost.
Segment
information for the three and nine months ended September 30, 2007 and 2006
is summarized as follows:
Three months ended September 30, 2007
|
|
Medical
Products
|
|
Personal
Care
|
|
Total
|
|
Net
sales
|
|
$
|
8,200,561
|
|
$
|
9,208,560
|
|
$
|
17,409,121
|
|
Gross
profit
|
|
|
3,813,874
|
|
|
2,644,266
|
|
|
6,458,140
|
|
Operating
(loss) income
|
|
|
(543,636
|
)
|
|
338,224
|
|
|
(205,412
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Total
assets as of September 30, 2007
|
|
|
27,116,263
|
|
|
49,690,173
|
|
|
76,806,436
|
|
Three months ended September
30, 2006
|
|
Medical
Products
|
|
Personal
Care
|
|
Total
|
|
Net
sales
|
|
$
|
8,086,567
|
|
$
|
978,749
|
|
$
|
9,065,316
|
|
Gross
profit
|
|
|
3,151,323
|
|
|
547,718
|
|
|
3,699,041
|
|
Operating
(loss) income
|
|
|
(624,852
|
)
|
|
113,151
|
|
|
(511,701
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Total
assets as of September 30, 2006
|
|
|
33,321,798
|
|
|
8,873,210
|
|
|
42,195,008
|
|
Nine months ended September 30, 2007
|
|
Medical
Products
|
|
Personal
Care
|
|
Total
|
|
Net
sales
|
|
$
|
24,702,681
|
|
$
|
25,238,640
|
|
$
|
49,941,321
|
|
Gross
profit
|
|
|
10,641,604
|
|
|
7,371,933
|
|
|
18,013,537
|
|
Operating
(loss) income
|
|
|
(2,140,415
|
)
|
|
1,294,900
|
|
|
(845,515
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Total
assets as of September 30, 2007
|
|
|
27,116,263
|
|
|
49,690,173
|
|
|
76,806,436
|
|
Nine months ended September 30, 2006
|
|
Medical
Products
|
|
Personal
Care
|
|
Total
|
|
Net
sales
|
|
$
|
24,370,885
|
|
$
|
2,232,996
|
|
$
|
26,603,881
|
|
Gross
profit
|
|
|
9,258,521
|
|
|
1,222,689
|
|
|
10,481,210
|
|
Operating
(loss) income
|
|
|
(2,384,054
|
)
|
|
171,013
|
|
|
(2,213,041
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Total
assets as of September 30, 2006
|
|
|
33,321,798
|
|
|
8,873,210
|
|
|
42,195,008
|
|
NOTE
10 — COMPREHENSIVE INCOME (LOSS)
The
Company’s comprehensive income (loss) was as follows:
|
|
Three months ended
September 30,
|
|
Nine months ended
September 30,
|
|
|
|
2007
|
|
2006
|
|
2007
|
|
2006
|
|
Net
loss
|
|
$
|
(837,036
|
)
|
$
|
(553,229
|
)
|
$
|
(2,471,586
|
)
|
$
|
(2,460,908
|
)
|
Other
comprehensive income (loss):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Change
in equity resulting from translation of financial statements into
U.S.
dollars
|
|
|
131,917
|
|
|
64,790
|
|
|
331,155
|
|
|
204,353
|
|
Comprehensive
loss
|
|
$
|
(705,119
|
)
|
$
|
(488,439
|
)
|
$
|
(2,140,431
|
)
|
$
|
(2,256,555
|
)
|
NOTE
11 — INCOME (LOSS) PER SHARE
Basic
earnings per common share (“EPS”) are computed based on the weighted average
number of common shares outstanding during each period. Diluted earnings per
common share are computed based on the weighted average number of common shares,
after giving effect to dilutive common stock equivalents outstanding during
each
period. The diluted income (loss) per share computations for the three months
ended September 30, 2007 and 2006 exclude approximately 1,963,000 and 1,816,000
shares, respectively, related to employee stock options because the effect
of
including them would be anti-dilutive. The diluted income (loss) per share
computations for the nine months ended September 30, 2007 and 2006 exclude
approximately 1,963,000 and 1,816,000 shares, respectively, related to employee
stock options because the effect of including them would be anti-dilutive.
The
impact of the 5% Convertible Notes and the 4% Convertible Notes on the
calculation of the fully-diluted earnings per share was anti-dilutive and is
therefore not included in the computation for each of the three and nine month
periods ended September 30, 2007 and 2006, respectively.
NOTE
12 — RELATED PARTY TRANSACTIONS
5%
Convertible Subordinated Notes
.
On December 8, 2006, the Company sold $28,880,000 of the Company’s 5%
Convertible Notes due December 7, 2011 in a private placement. The number of
shares of common stock issuable on conversion of the notes, as of September
30,
2007, is 6,195,165, and the conversion price as of such date was $4.6617. The
number of shares and conversion price are subject to adjustment in certain
circumstances. A trust controlled by Mr. Warren B. Kanders, the Company’s
Chairman of the Board of Directors and largest beneficial stockholder, owns
$2,000,000 of the 5% Convertible Notes, and one director, Stuart P. Greenspon,
owns $150,000 of the 5% Convertible Notes.
New
Employment Agreements
.
In
January 2007, the Company entered into three three-year employment agreements
as
part of the acquisitions of Regal and Twincraft. The employment agreements
were
issued to John Shero, the former President of Regal, who will now serve as
Vice
President of Sales of the medical products group, Peter A. Asch, who serves
as
President of Twincraft and the personal care division of the Company, and as
a
member of the Board of Directors, Lawrence Litke, who serves as Chief Operating
Officer of Twincraft. The Company also has a two-year employment agreement
with
Richard Asch, who serves in a sales managerial capacity at Twincraft. In
addition, the Company entered into a consulting agreement with Fifth Element,
LLC, a consulting firm controlled by Joseph Candido, who will serve as Vice
President of Sales and Marketing for Twincraft. The employment and consulting
agreements contain non-competition and non-solicitation provisions covering
the
terms of the agreements and for any extended severance periods and for one
year
after termination of the agreements or the extended severance periods, if
any.
In
July
2007, the Company entered into a three-year employment agreement with Kathleen
P. Bloch who was elected to become the Company’s Vice President and Chief
Financial Officer on September 4, 2007. The Company may terminate this agreement
at any time with or without cause, and the employee may terminate the agreement
with two weeks’ notice.
Effective
October 1, 2007, the Company entered into a new employment agreement with W.
Gray Hudkins, which replaced his employment agreement with the Company that
expired on September 30, 2007. The term of the agreement is for three years,
with a one-year renewal option. Mr. Hudkins has a right to six months’ severance
if his employment is terminated by the Company without cause, or if the Company
declines to renew the agreement for the one-year renewal term.
Mr.
Hudkins’
and Ms. Bloch’s agreements contain non-competition and non-solicitation
provisions. Per the terms of their agreements, both Mr. Hudkins and Ms. Bloch
are eligible to participate at the discretion of the Compensation Committee
and
the Board of Directors in the Company’s stock incentive plans.
NOTE
13 — PENSION
Prior
to
July 30, 1986, the Company maintained a non-contributory defined benefit pension
plan covering substantially all employees. Effective July 30, 1986, the Company
adopted an amendment to the plan under which future benefit accruals to the
plan
ceased (freezing the maximum benefits available to employees as of July 30,
1986), other than those required by law. Previously accrued benefits remain
in
effect and continue to vest under the original terms of the plan.
In
September 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined
Benefit Pension and Other Postretirement Plans, an amendment of FASB Statements
Nos. 87, 88, 106 and 132(R)” (“SFAS No.158”), which requires an entity to: (a)
recognize in its statement of financial position an asset for defined benefit
postretirement plan’s overfunded status or a liability for a plan’s underfunded
status, (b) measure a defined benefit postretirement plan’s assets and
obligations that determine its funded status as of the end of the employer’s
fiscal year, and (c) recognize changes in the funded status of a defined benefit
postretirement plan in comprehensive income in the year in which the changes
occur. The requirement to recognize the funded status of a defined benefit
postretirement plan and the disclosure requirements were effective in the
Company’s 2006 fiscal year.
|
|
Pension Benefits
|
|
Three months ended September 30:
|
|
2007
|
|
2006
|
|
Interest
cost
|
|
$
|
969
|
|
$
|
9,325
|
|
Expected
return on plan assets
|
|
|
(1,504
|
)
|
|
(13,273
|
)
|
Amortization
of transition obligations
|
|
|
22,236
|
|
|
1,947
|
|
Recognized
actuarial loss
|
|
|
—
|
|
|
4,932
|
|
Provision
for pension
|
|
|
25,588
|
|
|
—
|
|
Net
periodic benefit cost
|
|
$
|
47,289
|
|
$
|
2,931
|
|
|
|
Pension Benefits
|
|
Nine months ended September 30:
|
|
2007
|
|
2006
|
|
Interest
cost
|
|
$
|
3,381
|
|
$
|
28,002
|
|
Expected
return on plan assets
|
|
|
(5,225
|
)
|
|
(39,774
|
)
|
Amortization
of transition obligations
|
|
|
66,710
|
|
|
5,843
|
|
Recognized
actuarial loss
|
|
|
—
|
|
|
14,796
|
|
Provision
for pension
|
|
|
76,761
|
|
|
—
|
|
Net
periodic benefit cost
|
|
$
|
141,627
|
|
$
|
8,867
|
|
Employer
Contributions
The
Company previously disclosed in its consolidated financial statements for the
year ended December 31, 2006, that it does not expect to contribute to its
pension plan in 2007. In addition, the company is in the process of terminating
its pension plan by December 31, 2007. For the nine months ended September
30,
2007, no contributions have been made.
NOTE
14 — LITIGATION
In
connection with the Company’s acquisition of Silipos, the Company could become
subject to certain claims or actions brought by Poly-Gel, although no such
claims have been brought to date. These claims may arise, for example, out
of
the supply agreement between Silipos and Poly-Gel dated August 20, 1999, the
manufacture, marketing or sale of products made from gel not purchased from
Poly-Gel, alleged misappropriation of trade secrets or other confidential
information (including gel formulations) of Poly-Gel, as well as any other
alleged violations of the supply agreement (the “Potential Poly-Gel Claims”).
For any of these potential claims, SSL has agreed to indemnify the Company
for
losses up to $2.0 million, after which the Company would be liable for any
such
claims. Furthermore, the Company has assumed responsibility for the first
$150,000 of such liability in connection with the Company’s acquisition of
Silipos, and SSL’s maximum liability for total indemnification related to the
Company’s acquisition of Silipos is between $5,000,000 and $7,000,000. Thus, if
the total amount of all claims arising from the acquisition exceed this maximum,
whether or not related to Poly-Gel, the Company would be liable for amounts
in
excess of the maximum. For claims arising out of conduct that occurs after
the
closing of the Silipos transaction on September 30, 2004, the Company has agreed
to indemnify SSL against losses. The Company would expect to vigorously defend
against any claims brought by Poly-Gel or any other third party.
On
or
about February 13, 2006, Dr. Gerald P. Zook filed a demand for arbitration
with the American Arbitration Association, naming the Company and Silipos as
2
of the 16 respondents. (Four of the other respondents are the former owners
of
Silipos and its affiliates, and the other 10 respondents are unknown entities.)
The demand for arbitration alleges that the Company and Silipos are in default
of obligations to pay royalties in accordance with the terms of a license
agreement between Dr. Zook and Silipos dated as of January 1, 1997, with
respect to seven patents owned by Dr. Zook and licensed to Silipos. Silipos
has paid royalties to Dr. Zook, but Dr. Zook claims that greater
royalties are owed and also claims that Silipos improperly and without
authorization transferred Dr. Zook’s know-how to the former owner of Silipos.
The demand for arbitration seeks an award of $400,000 and reserves the right
to
seek a higher award after completion of discovery. Dr. Zook has agreed to
drop Langer, Inc. (but not Silipos) from the arbitration, without prejudice.
The
matter is in the discovery stage.
On
or
about February 13, 2006, Mr. Peter D. Bickel, who was the executive vice
president of Silipos, Inc., until January 11, 2006, alleged that he was
terminated by Silipos without cause and, therefore, was entitled, pursuant
to
his employment agreement, to a severance payment of two years’ base salary. On
or about February 23, 2006, Silipos commenced an action in New York State
Supreme Court, New York County, against Mr. Bickel seeking, among other
things, a declaratory judgment that Mr. Bickel is not entitled to severance
pay or other benefits, on account of his breach of various provisions of his
employment agreement with Silipos and his non-disclosure agreement with Silipos,
that Mr. Bickel resigned from his position or, alternatively, that his
termination by Silipos was for “cause” as defined in the employment agreement.
Silipos also sought compensatory and punitive damages for breaches of the
employment agreement, breach of the non-disclosure agreement, breach of
fiduciary duties, misappropriation of trade secrets, and tortious interference
with business relationships. On or about March 22, 2006, Mr. Bickel removed
the lawsuit to the United States District Court for the Southern District of
New
York and filed an answer denying the material allegations of the complaint
and
counterclaims seeking a declaratory judgment that his non-disclosure agreement
is unenforceable and that he is entitled to $500,000, representing two years’
base salary, in severance compensation, on the ground that Silipos did not
have
“cause” to terminate his employment. On August 8, 2006, the Court determined
that the restrictive covenant was enforceable against Mr. Bickel for the
duration of its term (which expired on January 11, 2007) to the extent of
prohibiting Mr. Bickel from soliciting certain key customers of the Company
with whom he had worked during his employment with the Company. The Company
has
withdrawn, without prejudice, its claims for compensatory and punitive damages
due to harm to its business as a result of Mr. Bickel’s actions. In response to
motions for summary judgment by Mr. Bickel and by Silipos, the court issued
an
opinion and order, dated October 12, 2007, dismissing all of Mr. Bickel's claims
against Silipos, denying Mr. Bickel's motion to dismiss the claims of Silipos
against him, and allowing Silipos to proceed with its claims for breach of
fiduciary duty and disloyalty against Mr. Bickel.
Additionally,
in the normal course of business, the Company may be subject to claims and
litigation in the areas of general liability, including claims of employees,
and
claims, litigation or other liabilities as a result of acquisitions completed.
The results of legal proceedings are difficult to predict and the Company cannot
provide any assurance that an action or proceeding will not be commenced against
the Company or that the Company will prevail in any such action or proceeding.
An unfavorable outcome of the arbitration proceeding commenced by
Dr. Gerald P. Zook against Silipos may adversely affect the Company’s
rights to manufacture and/or sell certain products or raise the royalty costs
of
those certain products.
An
unfavorable resolution of any legal action or proceeding could materially
adversely affect the market price of the Company’s common stock and its
business, results of operations, liquidity or financial
condition.
ITEM
2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Overview
We
design, manufacture and distribute high-quality medical products and services
targeting the long-term care, orthopedic, orthotic and prosthetic markets.
Through our wholly-owned subsidiaries Twincraft, Inc. (“Twincraft”), and
Silipos, Inc. (“Silipos”), we also offer a diverse line of personal care
products for the private label retail, medical, and therapeutic markets. We
sell
our medical products primarily in the United States and Canada, as well as
in
more than 30 other countries, to national, regional, and international
distributors, directly to healthcare professionals, and directly to patients
in
instances where we also are providing product fitting services. We sell our
personal care products primarily in North America to branded marketers of such
products, specialty retailers, direct marketing companies, and companies that
service various amenities markets. We acquired Twincraft, a leading designer
and
manufacturer of bar soap, and certain assets (the “Regal Assets” or “Regal”) of
Regal Medical Supply, LLC, a provider of contracture management products and
services to patients in long-term care and other rehabilitation settings, in
January 2007.
Our
broad
range of over 500 orthopedic products, including custom foot and ankle orthotic
devices, pre-fabricated foot products, rehabilitation products, and gel-based
orthopedic and prosthetics products, are designed to correct, protect, heal
and
provide comfort for the patient. Through our wholly owned subsidiary Regal
Medical Inc., starting in 2007 we also provide patient services in long-term
care settings by assisting facility personnel in product selection, order
fulfillment, product fitting and billing services. Our line of personal care
products includes bar soap, gel-based therapeutic gloves and socks, scar
management products, and other products that are designed to cleanse and
moisturize specific areas of the body, often incorporating essential oils,
vitamins and nutrients to improve the appearance and condition of the
skin.
Since
May
2002, we have consummated the following acquisitions:
|
·
|
Twincraft
.
On January 23, 2007, we acquired Twincraft, our largest acquisition
to
date, a designer and manufacturer of bar soap focused on the health
and
beauty, direct marketing, amenities and mass market channels. We
acquired
Twincraft to expand into additional product categories in the personal
care market, to increase our customer exposure for our current line
of
Silipos gel-based skincare products, and to take advantage of potential
commonalities in research and development advances between Twincraft’s and
our product groups. The aggregate consideration paid by us in connection
with this acquisition was approximately $30.6 million, including
transaction costs, paid in cash ($25,938,353) and common stock
($4,701,043, valued at $4.40 per share) of the Company. The sellers
of
Twincraft can earn additional deferred compensation in the years
2007 and
2008 based upon achievement of specific EBITDA targets per the terms
of
the Twincraft purchase agreement.
|
|
·
|
Regal
.
On January 8, 2007, we acquired the Regal Assets of Regal Medical
Supply,
LLC, a provider of contracture management products and services to
patients in long-term care and other rehabilitation settings. We
acquired
Regal as part of an effort to gain access to the long-term care market,
to
gain a captive distribution channel for certain custom products we
manufacture into markets we previously had been unable to penetrate,
to
obtain higher average selling prices for these products, and to establish
a national network of service professionals to enhance our customer
relationships in our core markets and new markets. The initial
consideration for the acquisition of the assets of Regal was approximately
$1.7 million, which has since been reduced to approximately $1.4
million
due to a shortfall in the amount of working capital delivered at
closing
and a future adjustment will be made related to receivables acquired
but
not collected.
|
|
·
|
Silipos
.
On September 30, 2004, we acquired Silipos, a leading designer,
manufacturer and marketer of gel-based products focusing on the
orthopedic, orthotic, prosthetic, and skincare markets. We acquired
Silipos because of its distribution channels and proprietary products,
and
to enable us to expand into additional product lines that are part
of our
market focus. The aggregate consideration paid by us in connection
with
this acquisition was approximately $17.3 million, including transaction
costs of approximately $2.0 million, paid in cash and
notes.
|
|
·
|
Bi-Op
.
On January 13, 2003, we acquired Bi-Op Laboratories, Inc. (“Bi-Op”), which
is engaged in the design, manufacture and sale of footwear and foot
orthotic devices as well as orthotic and prosthetic services. We
acquired
Bi-Op to gain access to additional markets and complementary product
lines. The aggregate consideration, including transaction costs,
was
approximately $2.2 million, of which approximately $1.8 million was
paid
in cash, and the remaining portion was paid through the issuance
of
107,611 shares of our common stock.
|
|
·
|
Benefoot
.
On May 6, 2002, we acquired the net assets of Benefoot, Inc., and
Benefoot
Professional Products, Inc. (together, “Benefoot”). Benefoot designs,
manufactures, and distributes custom orthotics, custom
Birkenstock
Ò
sandals, therapeutic shoes, and prefabricated orthotic devices to
healthcare professionals. We acquired Benefoot to gain additional
scale in
our core custom orthotics business as well as to gain access to
complementary product lines. The aggregate consideration, including
transaction costs, was approximately $7.9 million, of which approximately
$5.6 million was paid in cash, $1.8 million was paid through the
issuance
of 4% promissory notes, and approximately $0.5 million was paid through
the issuance of 61,805 shares of common stock. In connection with
this
acquisition, we also assumed certain liabilities of Benefoot, including
approximately $0.3 million of long-term indebtedness which was paid
at
closing.
|
We
intend
to begin a study of strategic alternatives available to us regarding our various
operating companies, in order to insure that we are taking all steps possible
to
maximize shareholder value. We will continue to consider acquisitions in our
target markets, if appropiate, and to examine the possibility of divestiture
of
certain assets. We expect the evaluation of alternatives to be
substantially complete by June 30, 2008.
We
sell
our medical products directly to health care professionals and also to wholesale
distributors. Custom orthotic products are primarily sold directly to health
care professionals. Other products sold in our medical products business are
sold both directly to health care professionals and to distributors. Products
sold in our personal care business are sold primarily to wholesale distributors.
Revenue from product sales is recognized at the time of shipment. Our most
significant expense is cost of sales. Cost of sales consists of materials,
direct labor and overhead, and related shipping costs. General and
administrative expenses consist of fees paid to professionals, amortization
of
identifiable intangible assets with definite lives, executive, accounting,
and
administrative salaries and related expenses, insurance, pension expenses,
bank
service charges, and stockholder relations. Selling expenses consist of sales
and marketing salaries, commissions and related expenses, advertising,
promotions, conventions, and travel and entertainment.
Of
our total revenues derived for the nine months ended September 30, 2007 and
2006, 88.7% and 81.2%, respectively, was generated in the United States, and
6.7% and 11.0%, respectively, was generated from the United Kingdom, and 4.6%
and 7.8%, respectively, was generated from Canada. Of our total revenues derived
for the three months ended September 30, 2007 and 2006, 89.2% and 81.7%,
respectively, was generated in the United States, and 6.3% and 11.0%,
respectively, was generated from the United Kingdom, and 4.5% and 7.3%,
respectively, was generated from Canada.
We
operate in two segments, medical products and personal care. Prior to January
1,
2007, the medical products segment was called the orthopedic segment and the
personal care segment was called the skincare segment. We consummated two
acquisitions (Twincraft and Regal) in January 2007. The operations from the
Twincraft acquisition are included in the personal care segment, and the
operations from the Regal acquisition are included in the medical products
segment. In addition, the medical products segment includes the orthopedic
products of Silipos.
The
acquisition of Twincraft had a dramatic impact on the mix of our segment
revenues. For the nine months ended September 30, 2007, our personal care
segment represented 50.5% of our total revenue, compared to 8.4% of total
revenue for the nine months ended September 30, 2006. Medical products, on
the
other hand, represented only 49.5% of our total revenue for the nine months
ended September 30, 2007, compared to 91.6% of our total revenue for the nine
months ended September 30, 2006. This trend continues in the three months ended
September 30, 2007 with personal care representing 52.9% of our total revenue
and medical products at 47.1% of total revenue.
On
a pro
forma basis, after giving effect to our acquisitions of Twincraft and Regal
as
of January 1, 2006, 47.7% and 53.1% of our revenues for the nine months ended
September 30, 2007 and 2006, respectively, would have been derived from our
medical products segment, and 52.3% and 46.9% of our revenue for the nine months
ended September 30, 2007 and 2006, respectively, would have been derived from
our personal care segment.
On
a pro
forma basis, after giving effect to our acquisitions of Twincraft and Regal
as
of January 1, 2006, 47.1% and 52.7% of our revenues for the three months ended
September 30, 2007 and 2006, respectively, would have been derived from our
medical products segment, and 52.9% and 47.3% of our revenue for the three
months ended September 30, 2007 and 2006, respectively, would have been derived
from our personal care segment.
Critical
Accounting Policies and Estimates
Our
accounting policies are more fully described in Note 1 of the Notes to the
Consolidated Financial Statements included in our annual report on
Form 10-K for the year ended December 31, 2006. The preparation of
financial statements in conformity with accounting principles generally accepted
in the United States of America requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Future events and their effects cannot be determined with
absolute certainty. Therefore, the determination of estimates requires the
exercise of judgment. Actual results may differ from these estimates under
different assumptions or conditions. The following are the only updates or
changes to Part II, Item 7, “Management’s Discussion and Analysis of Financial
Condition and Results of Operations - Critical Accounting Policies and
Estimates” in the Company’s annual report on Form 10-K for the fiscal year ended
December 31, 2006.
Goodwill
and Identifiable Intangible Assets.
Goodwill
represents the excess of purchase price over fair value of identifiable net
assets of acquired businesses. Identifiable intangible assets primarily
represent allocations of purchase price to identifiable intangible assets of
acquired businesses. Because of our strategy of growth through acquisitions,
goodwill and other identifiable intangible assets comprise a substantial portion
(48.2% at September 30, 2007 and 29.2% at December 31, 2006) of our total
assets. Goodwill and identifiable intangible assets, net, at September 30,
2007
and December 31, 2006 were approximately $36,987,000 and approximately
$20,080,000, respectively.
The
purchase price allocated to the identifiable intangible assets of trade names
and customer relationships as pertaining to the acquisition of Twincraft were
based on a variation of the income approach to determine the fair value of
these
assets. The income approach was used due to the ability of these assets to
generate current and future income. The customer relationships’ fair market
value was estimated by using the excess earnings method, by which the Company
estimated the annual attrition rate of the Company’s customer relationships. The
Company utilized the royalty savings method to estimate the fair value of
Twincraft’s trade names. In subsequent reporting periods, the Company will test
goodwill under Statement of Financial Accounting Standards (“SFAS”) No. 142,
“Goodwill and Other Intangible Assets,” to determine whether it has been
impaired, and will test identifiable intangible assets with definite lives
pursuant to SFAS No. 144, “Accounting for the Impairment or Disposal of
Long-Lived Assets.”
Adoption
of FIN 48.
Upon the
adoption of Interpretation No. 48, “Accounting for Uncertainty in Income Taxes”
(“FIN 48”) on January 1, 2007, we performed a thorough review of our tax returns
not yet closed due to the statute of limitations and other currently pending
tax
positions of the Company. We reviewed and analyzed our tax records and
documentation supporting tax positions for purposes of determining the presence
of any uncertain tax positions and confirming other tax positions as certain
under FIN 48. We reviewed and analyzed our records in support of tax
positions represented by both permanent and timing differences in reporting
income and deductions for tax and accounting purposes. We maintain a
policy, consistent with principals under FIN 48, to continually monitor past
and
present tax positions.
Nine
months ended September 30, 2007 and 2006
Net
loss
for the nine months ended September 30, 2007 was approximately $(2,472,000),
or
$(.22) per share on a fully diluted basis, compared to a net loss of
approximately $(2,461,000), or $(.25) per share on a fully diluted basis for
the
nine months ended September 30, 2006. The significant factors impacting our
operating results are discussed below.
Net
sales for the nine months ended September 30, 2007 were approximately
$49,941,000, compared to approximately $26,604,000 for the nine months ended
September 30, 2006, an increase of approximately $23,337,000, or 87.7%. The
principal reasons for the increase were the net sales of approximately
$20,691,000 and approximately $2,741,000 generated by Twincraft and Regal,
respectively.
Net
sales
of medical products were approximately $24,702,000 in the nine months ended
September 30, 2007, compared to approximately $24,371,000 in the nine months
ended September 30, 2006, an increase of approximately $331,000 or 1.4%. Of
this
increase, Regal generated approximately $2,741,000. The remaining decrease
of
approximately $2,410,000 was due to the net sales decrease of approximately
$1,356,000, or 16.4%, from the medical products segment of Silipos, and an
additional decrease in net sales in our medical products business, excluding
Silipos, of approximately $1,054,000, or 6.5%.
Within
the medical products segment, net sales of custom orthotics for the nine months
ended September 30, 2007 were approximately $11,909,000, compared to
approximately $12,410,000 for the nine months ended September 30, 2006, a
decrease of approximately $501,000, or 4.0%.
Also
within the medical products segment, net sales of distributed products for
the
nine months ended September 30, 2007 were approximately $3,147,000, compared
to
approximately $3,700,000 for the nine months ended September 30, 2006, a
decrease of approximately $553,000, or 14.9%. This decrease was attributable
to
the decrease in the net sales of our therapeutic footwear program of
approximately $484,000, and in the net sales of other distributed products
of
approximately $164,000, which was partially offset by an increase in net sales
of PPT
Ò
,
a
proprietary product, of approximately $95,000 in the nine months ended September
30, 2007, compared to the nine months ended September 30, 2006.
Net
sales
of Silipos branded medical products were approximately $6,905,000 in the nine
months ended September 30, 2007, compared to approximately $8,261,000 in the
nine months ended September 30, 2006, a decrease of approximately $1,356,000,
or
16.4%, due to increasing competition from other suppliers of these
products.
We
generated net sales of approximately $25,239,000 in our personal care segment
in
the nine months ended September 30, 2007, compared to approximately $2,233,000
in the nine months ended September 30, 2006, an increase of approximately
$23,006,000. Of this increase, Twincraft generated approximately $20,691,000.
The remaining increase of approximately $2,315,000 was due to increases in
the
net sales generated by the personal care segment of Silipos. Net sales in
Silipos’ personal care segment represented 39.7% of Silipos’ net sales for the
nine months ended September 30, 2007, compared to 21.3% for the nine months
ended September 30, 2006. The increase in Silipos’ net sales in the personal
care segment is due to higher volumes with our current customer base, and an
increase in new retail customers.
Cost
of
sales, on a consolidated basis, increased approximately $15,805,000, or 98.0%,
to approximately $31,928,000 for the nine months ended September 30, 2007,
compared to approximately $16,123,000 for the nine months ended September 30,
2006. This increase was primarily attributable to the acquisitions of Twincraft
and Regal, which had cost of sales of approximately $15,492,000 and
approximately $743,000, respectively, in the nine months ended September 30,
2007, offset by a decrease in cost of sales in our historic business (including
Silipos) of approximately $430,000, which was attributable to a decrease in
sales.
Cost
of
sales in the medical products segment were approximately $14,061,000, or 56.9%
of medical products net sales in the nine months ended September 30, 2007,
compared to approximately $15,113,000, or 62.0% of medical products net sales
in
the nine months ended September 30, 2006. This 5.1% decrease in cost of sales,
as a percentage of net sales, is due to improved overhead
absorption.
Cost
of
sales for custom orthotics was approximately $8,485,000, or 71.2% of net sales
of custom orthotics for the nine months ended September 30, 2007, compared
to
approximately $9,490,000, or 76.5% of net sales of custom orthotics for the
nine
months ended September 30, 2006. Reductions in the cost of sales are primarily
due to the closure of our Anaheim production facility in June 2007, which
reduced our overhead associated with the production of custom orthotics. Cost
of
sales of historic distributed products were approximately $2,098,000, or 66.7%
of net sales of distributed products in the medical products business for the
nine months ended September 30, 2007, compared to approximately $2,372,000,
or
64.1% of net sales of distributed products in the medical products business
for
the nine months ended September 30, 2006.
Cost
of
sales for Silipos’ branded medical products were approximately $2,735,000, or
39.6% of net sales of Silipos’ branded medical products of approximately
$6,905,000 in the nine months ended September 30, 2007, compared to
approximately $3,251,000, or 39.4% of net sales of Silipos’ branded medical
products of approximately $8,261,000 in the nine months ended September 30,
2006.
Cost
of
sales for the personal care products were approximately $17,867,000, or 70.8%
of
net sales of personal care products of approximately $25,239,000 in the nine
months ended September 30, 2007, compared to approximately $1,010,000, or 45.2%
of net sales of personal care products of approximately $2,233,000 in the nine
months ended September 30, 2006. Excluding Twincraft’s cost of sales of
approximately $15,492,000, Silipos’ cost of sales increase of approximately
$1,365,000 for its personal care products was attributable to its increase
in
net sales of personal care products of approximately $2,315,000, in addition
to
increases in certain material costs.
Consolidated
gross profit increased approximately $7,532,000, or 71.9%, to approximately
$18,013,000 for the nine months ended September 30, 2007, compared to
approximately $10,481,000 for the nine months ended September 30, 2006.
Consolidated gross profit as a percentage of net sales for the nine months
ended
September 30, 2007 was 36.1%, compared to 39.4% for the nine months ended
September 30, 2006. The blended gross profit percentage decreased for the nine
months ended September 30, 2007, compared to the nine months ended September
30,
2006, due to a lower average gross profit margin in our new Twincraft business.
The principal reason for the nominal increase in gross profit was the gross
profit contributions of Twincraft and Regal of approximately $5,199,000 and
$1,998,000, respectively. Twincraft’s and Regal’s gross profit as a percentage
of their respective net sales for the nine months ended September 30, 2007
was
25.1% and 72.9%, respectively. This increase in consolidated gross profit also
included an increase in gross profit of approximately $335,000 in our historic
business, of which Silipos’ gross profit increase was approximately $110,000.
Silipos’ blended gross profit (including both medical products and personal care
products) as a percentage of its net sales for the nine months ended September
30, 2007 was 55.4%, compared to 59.4% for the nine months ended September 30,
2006.
Gross
profit for the medical products segment was approximately $10,641,000, or 43.1%
of net sales of the medical products segment in the nine months ended September
30, 2007, compared to approximately $9,258,000, or 38.0% of net sales of the
medical products segment in the nine months ended September 30,
2006.
Gross
profit for custom orthotics was approximately $3,424,000, or 28.8% of net sales
of custom orthotics for the nine months ended September 30, 2007, compared
to
approximately $2,920,000, or 23.5% of net sales of custom orthotics for the
nine
months ended September 30, 2006. This improvement in gross profit was primarily
due to the closure of our Anaheim production facility and the resulting
consolidation of manufacturing activities, which reduced our overhead costs.
Gross profit for our historic distributed products was approximately $1,049,000,
or 33.3% of net sales of distributed products in the medical products business
for the nine months ended September 30, 2007, compared to approximately
$1,328,000, or 35.9% of net sales of distributed products in the medical
products business for the nine months ended September 30, 2006. The decrease
in
gross profit in distributed products from our historical business was primarily
attributable to a decrease in net sales of our therapeutic footwear distributed
products.
Gross
profit generated by Silipos’ branded medical product sales was approximately
$4,170,000, or 60.4% of net sales of Silipos’ branded medical products for the
nine months ended September 30, 2007, compared to approximately $5,010,000,
or
60.6% of net sales of Silipos’ branded medical products for the nine months
ended September 30, 2006.
Gross
profit generated by our personal care segment was approximately $7,372,000,
or
29.2% of net sales in the personal care segment for the nine months ended
September 30, 2007, compared to approximately $1,223,000, or 54.8% of net sales
in the personal care segment for the nine months ended September 30, 2006.
This
increase in gross profit is primarily the result of the additional gross profit
contribution of approximately $5,199,000 of Twincraft. The principal reason
for
the decrease in gross profit percentage is due to a lower average gross profit
margin in our new Twincraft business of 25.1%. The gross profit generated by
Silipos’ personal care segment was approximately $2,173,000, or 47.8% of
Silipos’ net sales in the personal care segment for the nine months ended
September 30, 2007, compared to approximately $1,223,000, or 54.8% of Silipos’
net sales in the personal care segment for the nine months ended September
30,
2006.
General
and administrative expenses for the nine months ended September 30, 2007 were
approximately $10,823,000, or 21.7% of net sales, compared to approximately
$7,188,000, or 27.0% of net sales for the nine months ended September 30, 2006,
representing an increase of approximately $3,635,000. Twincraft generated
approximately $1,740,000 of general and administrative expenses in the nine
months ended September 30, 2007. The remaining increase of $1,895,000 was
attributable to an increase in professional fees of approximately $1,286,000,
which includes fees paid to a financial service consulting firm of approximately
$834,000 and consulting fees paid for Sarbanes-Oxley compliance of approximately
$79,000, an increase in depreciation expense and amortization of identifiable
intangible assets of approximately $533,000, an increase in pension provision
of
approximately $89,000 related to the retirement of our pension plan, lease
abandonment costs of approximately $72,000 related to the closing of our
Anaheim, California facility, one-time recruitment fees for the new Chief
Financial Officer of $70,000, an increase in stock-based compensation expense
of
approximately $56,000, an increase in directors fees of $54,000, which were
offset by a decease in information technology related consulting fees of
approximately $123,000, a decrease in stockholder relation fees of approximately
$66,000, and a decrease in other net general and administrative expenses of
approximately $76,000.
Selling
expenses increased approximately $2,316,000, or 45.5%, to approximately
$7,405,000 for the nine months ended September 30, 2007, compared to
approximately $5,089,000 for the nine months ended September 30, 2006. Selling
expenses as a percentage of net sales were 14.8% in the nine months ended
September 30, 2007, compared to 19.1% in the nine months ended September 30,
2006. Twincraft and Regal generated approximately $2,272,000 and $1,917,000,
respectively, of selling expenses in the nine months ended September 30, 2007.
The remaining decrease of $1,873,000 is primarily attributable to the
consolidation of personnel and related selling expenses in our medical products
business that are now combined within Regal, and our continuing efforts to
reduce selling expenses as sales decline in our medical products
business.
Research
and development expenses increased from approximately $417,000 in the nine
months ended September 30, 2006, to approximately $630,000 in the nine months
ended September 30, 2007, an increase of approximately $213,000, or 51.1%,
which
was attributable to the inclusion of Twincraft’s research and development
expenses of approximately $283,000, which was offset by a decrease of
approximately $70,000 of Silipos’ research and development
expenses.
Interest
expense was approximately $1,633,000 for the nine months ended September 30,
2007, compared to approximately $800,000 for the nine months ended September
30,
2006, an increase of approximately $833,000. The principal reason for the
increase was that the nine months ended September 30, 2007 included interest
expense of approximately $1,146,000 associated with the $28,880,000 principal
amount of 5% convertible subordinated notes due December 7, 2011 (the “5%
Convertible Notes”), compared to interest expense of approximately $385,000
associated with the $14,589,000 principal amount of 4% convertible subordinated
notes, which were paid August 31, 2006 (the “4% Convertible
Notes”).
Interest
income was approximately $231,000 in the nine months ended September 30, 2007,
compared to approximately $522,000 in the nine months ended September 30, 2006.
In the nine months ended September 30, 2006, the Company generated interest
income related to the investment of approximately $14,500,000 until these
proceeds were used on August 31, 2006 to repay the 4% Convertible
Notes.
The
provision for income taxes was approximately $210,000 in the nine months ended
September 30, 2007, compared to a (benefit from) income taxes of approximately
$(6,000) in the nine months ended September 30, 2006. The current year’s expense
is attributable to an increase in deferred taxes related to certain intangible
assets and a provision for state taxes related to the operations of
Twincraft.
Three
months ended September 30, 2007 and 2006
Net
loss
for the three months ended September 30, 2007 was approximately $(837,000),
or
$(.07) per share on a fully diluted basis, compared to a net loss of
approximately $(553,000), or $(.06) per share on a fully diluted basis for
the
three months ended September 30, 2006. The significant factors impacting our
operating results are discussed below.
Net
sales
for the three months ended September 30, 2007 were approximately $17,409,000,
compared to approximately $9,065,000 for the three months ended September 30,
2006, an increase of approximately $8,344,000, or 92.0%. The principal reasons
for the increase were the net sales of approximately $7,010,000 and
approximately $1,076,000 generated by the acquisitions in January 2007 of
Twincraft and Regal, respectively.
Net
sales
of medical products were approximately $8,200,000 in the three months ended
September 30, 2007, compared to approximately $8,086,000 in the three months
ended September 30, 2006, an increase of approximately $114,000, or 1.4%. Regal
contributed approximately $1,076,000 of net sales. The balance represented
decreases of approximately $360,000, or 13.5%, due to the net sales decrease
from the medical products segment of Silipos, and an additional decrease of
approximately $602,000, or 11.1%, due to the net sales decrease in our medical
products business, excluding Silipos.
Within
the medical products segment, net sales of custom orthotics for the three months
ended September 30, 2007 were approximately $3,877,000, compared to
approximately $4,153,000 for the three months ended September 30, 2006, a
decrease of approximately $276,000, or 6.6%.
Also
within the medical products segment, net sales of distributed products for
the
three months ended September 30, 2007 were approximately $941,000, compared
to
approximately $1,267,000 for the three months ended September 30, 2006, a
decrease of approximately $326,000, or 25.7%. This decrease was attributable
to
a decrease in the sales of our therapeutic footwear program of approximately
$205,000, and in the net sales of other distributed products of approximately
$37,000, and in the net sales of PPT
Ò
,
a
proprietary product, of approximately $84,000 in the three months ended
September 30, 2007, compared to the three months ended September 30,
2006.
Net
sales
of Silipos branded medical products were approximately $2,306,000 in the three
months ended September 30, 2007, compared to approximately $2,666,000 in the
three months ended September 30, 2006, a decrease of approximately $360,000,
or
13.5%, due to increasing competition from other suppliers of these
products.
We
generated net sales of approximately $9,209,000 in our personal care segment
in
the three months ended September 30, 2007, compared to approximately $979,000
in
the three months ended September 30, 2006, an increase of approximately
$8,230,000. Of this increase, Twincraft generated approximately $7,010,000.
The
remaining increase of approximately $1,220,000 was due to the net sales
generated by the personal care segment of Silipos. Net sales in Silipos’
personal care segment represented 48.8% of Silipos’ net sales for the three
months ended September 30, 2007, compared to 26.9% for the three months ended
September 30, 2006. The increase in Silipos’ net sales in the personal care
segment is due to higher volumes with our current customer base, and an increase
in new retail customers.
Cost
of
sales, on a consolidated basis, increased approximately $5,585,000, or 104.1%,
to approximately $10,951,000 for the three months ended September 30, 2007,
compared to approximately $5,366,000 for the three months ended September 30,
2006. This increase was primarily attributable the acquisitions of Twincraft
and
Regal, which had cost of sales of approximately $5,397,000 and approximately
$298,000, respectively, in the three months ended September 30, 2007, offset
by
a decrease in cost of sales in our historic business (including Silipos) of
approximately $110,000, which is correlated to the decrease in
sales.
Cost
of
sales in the medical products segment were approximately $4,386,000, or 53.5%
of
medical products net sales in the three months ended September 30, 2007,
compared to approximately $4,935,000, or 61.0% of medical products net sales
in
the three months ended September 30, 2006.
Cost
of
sales for custom orthotics were approximately $2,628,000, or 67.8% of net sales
of custom orthotics for the three months ended September 30, 2007, compared
to
approximately $3,122,000, or 75.2% of net sales of custom orthotics for the
three months ended September 30, 2006. Reductions in the cost of sales are
primarily due to the closure of our Anaheim production facility in June 2007,
which reduced our overhead associated with the production of custom orthotics.
Cost of sales of historic distributed products were approximately $601,000,
or
63.9% of net sales of distributed products in the medical products business
for
the three months ended September 30, 2007, compared to approximately $840,000,
or 66.3% of net sales of distributed products in the medical products business
for the three months ended September 30, 2006.
Cost
of
sales for Silipos’ branded medical products were approximately $859,000, or
37.3% of net sales of Silipos’ branded medical products of approximately
$2,306,000 in the three months ended September 30, 2007, compared to
approximately $973,000, or 36.5% of net sales of Silipos’ branded medical
products of approximately $2,666,000 in the three months ended September 30,
2006.
Cost
of
sales for the personal care products were approximately $6,565,000, or 71.3%
of
net sales of personal care products of approximately $9,209,000 in the three
months ended September 30, 2007, compared to approximately $431,000, or 44.0%
of
net sales of personal care products of approximately $979,000 in the three
months ended September 30, 2006. Excluding Twincraft’s cost of sales of
approximately $5,397,000, Silipos’ cost of sales increase of approximately
$737,000 for its personal care products was attributable to its increased net
sales of personal care products of approximately $1,220,000.
Consolidated
gross profit increased approximately $2,759,000, or 74.6%, to approximately
$6,458,000 for the three months ended September 30, 2007, compared to
approximately $3,699,000 in the three months ended September 30, 2006.
Consolidated gross profit as a percentage of net sales for the three months
ended September 30, 2007 was 37.1%, compared to 40.8% for the three months
ended
September 30, 2006. The blended gross profit percentage decreased for the three
months ended September 30, 2007, compared to the three months ended September
30, 2006 due to a lower average gross profit margin in our new Twincraft
business. The principal reason for the nominal increase in gross profit was
the
gross profit contributions of Twincraft and Regal of approximately $1,613,000
and $778,000, respectively. Twincraft’s and Regal’s gross profit as a percentage
of its net sales for the three months ended September 30, 2007 was 23.0% and
72.3%, respectively. This increase in consolidated gross profit also included
an
increase in gross profit of approximately $368,000 in our historic business
(including Silipos).
Gross
profit for the medical products segment was approximately $3,814,000, or 46.5%
of net sales of the medical products segment in the three months ended September
30, 2007, compared to approximately $3,151,000, or 39.0% of net sales of the
medical products segment in the three months ended September 30,
2006.
Gross
profit for custom orthotics was approximately $1,249,000, or 32.2% of net sales
of custom orthotics for the three months ended September 30, 2007, compared
to
approximately $1,031,000, or 24.8% of net sales of custom orthotics for the
three months ended September 30, 2006 as a result of improved overhead
absorption due to the closure of our Anaheim production facility. Gross profit
for our historic distributed products was approximately $340,000, or 36.1%
of
net sales of distributed products in the medical products business for the
three
months ended September 30, 2007, compared to approximately $427,000, or 33.7%
of
net sales of distributed products in the medical products business for the
three
months ended September 30, 2006. The decreases in gross profit in distributed
products from our historical business was primarily attributable to a decrease
in net sales of our therapeutic footwear distributed products.
Gross
profit generated by Silipos’ branded medical product sales was approximately
$1,447,000, or 62.7% of net sales of Silipos’ branded medical products for the
three months ended September 30, 2007, compared to approximately $1,693,000,
or
63.5% of net sales of Silipos’ branded medical products for the three months
ended September 30, 2006.
Gross
profit generated by our personal care segment was approximately $2,644,000,
or
28.7% of net sales in the personal care segment for the three months ended
September 30, 2007, compared to approximately $548,000, or 56.0% of net sales
in
the personal care segment for the three months ended September 30, 2006. The
principal reason for the decrease in gross profit percentage is due to a lower
average gross profit margin in our new Twincraft business of 23.0%. The gross
profit generated by Silipos’ personal care segment was approximately $1,031,000,
or 46.9% of Silipos’ net sales in the personal care segment for the three months
ended September 30, 2007, compared to approximately $548,000, or 56.0% of
Silipos’ net sales in the personal care segment for the three months ended
September 30, 2006.
General
and administrative expenses for the three months ended September 30, 2007 were
approximately $3,848,000, or 22.1% of net sales, compared to approximately
$2,493,000, or 27.5% of net sales for the three months ended September 30,
2006,
representing an increase of approximately $1,355,000. Twincraft generated
approximately $599,000 of general and administrative expenses in the three
months ended September 30, 2007. The remaining increase of $756,000 was
attributable to an increase in professional fees of approximately $769,000,
of
which approximately $354,000 related to fees paid to a financial service
consulting firm and consulting fees paid for Sarbanes-Oxley compliance of
approximately $79,000, which was offset by a decrease in other net general
and
administrative expenses of approximately $13,000.
Selling
expenses increased approximately $1,025,000, or 65.4%, to approximately
$2,592,000 for the three months ended September 30, 2007, compared to
approximately $1,567,000 for the three months ended September 30, 2006. Selling
expenses as a percentage of net sales were 14.9% in the three months ended
September 30, 2007, compared to 17.3% in the three months ended September 30,
2006. Twincraft and Regal generated approximately $820,000 and $748,000,
respectively, of selling expenses in the three months ended September 30, 2007.
The principal reasons for the remaining decrease of $543,000 is primarily
attributable to the consolidation of personnel and related selling expenses
in
our medical products business that are now combined with Regal, and our
continuing efforts to reduce selling expenses as sales decline in our medical
products business.
Research
and development expenses increased from approximately $152,000 in the three
months ended September 30, 2006, to approximately $223,000 in the three months
ended September 30, 2007, an increase of approximately $71,000, or 46.7%, which
was attributable to the inclusion of Twincraft’s research and development
expenses of approximately $107,000, which was offset by a decrease of
approximately $36,000 of Silipos’ research and development
expenses.
Interest
expense was approximately $557,000 for the three months ended September 30,
2007, compared to approximately $218,000 for the three months ended September
30, 2006, an increase of approximately $339,000. The principal reason for the
increase was that the three months ended September 30, 2007 included interest
expense of approximately $383,000 associated with the 5% Convertible Notes,
compared to interest expense of approximately $96,000 associated with the 4%
Convertible Notes.
Interest
income was approximately $23,000 in the three months ended September 30, 2007,
compared to approximately $152,000 in the three months ended September 30,
2006.
In the three months ended September 30, 2006, the Company generated interest
income related to the investment of approximately $14,500,000 until these
proceeds were used on August 31, 2006 to repay the 4% Convertible
Notes.
The
provision for income taxes was approximately $102,000 in the three months ended
September 30, 2007, compared to a (benefit from) income taxes of approximately
$(21,000) in the three months ended September 30, 2006. The current year’s
expense is attributable to an increase in deferred taxes related to certain
intangible assets and a provision for state taxes related to the operations
of
Twincraft.
Liquidity
and Capital Resources
Working
capital as of September 30, 2007 was approximately $14,584,000, compared to
approximately $33,312,000 as of December 31, 2006. At December 31, 2006, working
capital included the proceeds from the issuance of the 5% Convertible Notes,
which proceeds were used to purchase Twincraft on January 23, 2007. Excluding
the cash from the 5% Convertible Notes, working capital increased by $10,152,000
from December 31, 2006 to September 30, 2007, due primarily to the acquisitions
of Twincraft and Regal.
Cash
balances at September 30, 2007 decreased by approximately $27,946,000, from
cash
balances at December 31, 2006, of which $25,901,387 represented cash used to
acquire Twincraft. In addition, due principally to the 2007 acquisitions,
accounts receivable increased approximately $6,208,000, inventory increased
approximately $4,579,000, and prepaid and other current expenses increased
approximately $997,000, which was partially offset by increases in accounts
payable and other current liabilities of $3,605,000.
Net
cash
provided by operating activities was approximately $206,000 for the nine months
ended September 30, 2007. For the nine months ended September 30, 2007, the
most
significant items providing cash from operations include depreciation and
amortization expense of $2,889,102, due to the Twincraft acquisition, which
included identifiable intangible assets of approximately $9,408,000, a decrease
in other assets of $778,200, and an increase in accounts payable and other
current liabilities of $561,626. The decline in other assets is due largely
to
the capitalization of professional fees in the first quarter of 2007 of
approximately $957,000 incurred in connection with the acquisitions of Twincraft
and Regal, which were classified as other assets at December 31, 2006. The
net
cash used in operating activities in the nine months ended September 30, 2006
resulted primarily from increases in accounts receivable and other assets,
cash
used in operations resulting from the net loss incurred, plus depreciation
and
amortization expense, amortization of debt acquisition costs, and stock-based
compensation expense.
Net
cash
used in investing activities was approximately $27,972,000 and approximately
$849,000 in the nine months ended September 30, 2007 and 2006,
respectively. Net cash used in investing activities in the nine months ended
September 30, 2007 reflects the net cash proceeds used for the purchase of
the
Twincraft acquisition of approximately $25,901,000, in addition to the increase
in restricted cash held in escrow required for this acquisition totaling
$1,000,000, and the purchases of property and equipment, net of disposals,
of
approximately $1,072,000, principally related to purchases of production
equipment and the purchase of a new consolidation and financial reporting
software system. Net cash used in investing activities in the nine months ended
September 30, 2006 reflects the purchases of property and equipment of
approximately $851,000, offset by the proceeds of the sales of certain property
and equipment of approximately $2,000.
Net
cash
used in financing activities was approximately $249,000 and approximately
$14,401,000 in the nine months ended September 30, 2007 and 2006, respectively.
Net cash used in financing activities in the nine months ended September 30,
2007 includes $267,492 in banking and professional fees paid in connection
with
the establishment of our credit facility with Wachovia Bank. In the nine months
ended September 30, 2006, net cash used for financing activities of $14,401,277
was primarily because of the repayment of $14,439,000 of 4% Convertible Notes
due as of August 31, 2006.
Our
principal cash needs are to provide working capital, and service our long-term
debt and to fund growth.
We
believe that, based on current levels of operations and anticipated growth,
cash
to be generated from operations, together with other available sources of
liquidity, including borrowings available under our new Credit Facility, will
be
sufficient for the next twelve months to fund anticipated capital expenditures
and make the required payments of interest on the 5% Convertible Notes. There
can be no assurance, however, that our business will generate cash flow from
operations sufficient to enable us to fund our liquidity needs. In addition,
our
growth strategy contemplates making further acquisitions, and we may need to
raise additional funds for this purpose. We may finance acquisitions of other
companies or product lines in the future from existing cash balances, through
borrowings from banks or other institutional lenders, and/or public or private
offerings of debt or equity securities. We cannot make any assurances that
any
such funds will be available to us on favorable terms, or at all. In the nine
months ended September 30, 2007, we generated a net loss of approximately
$(2,472,000), compared to a net loss of approximately $(2,461,000) for the
nine
months ended September 30, 2006.
On
May
11, 2007, we entered into a $20 million secured revolving credit facility
agreement (the “Credit Facility”) with Wachovia Bank, National Association,
expiring on September 30, 2011, which bears interest at the lender’s prime rate
or, at the Company’s election, at 2 percentage points above an Adjusted
Eurodollar Rate, as defined. The obligations under the Credit Facility are
guaranteed by the Company’s domestic subsidiaries and are secured by a first
priority security interest in all the assets of the Company and its
subsidiaries. The Credit Facility requires compliance with various covenants
including but not limited to a Fixed Charge Coverage Ratio of not less than
1.0
to 1.0 at all times when excess availability is less than $3 million. As of
September 30, 2007, the Company has not made draws on the Credit Facility and
has approximately $6.1 million available under the Credit Facility. Availability
under the Credit Facility is reduced by 40% of the outstanding letters of credit
related to the purchase of eligible inventory, as defined, and 100% of all
other
outstanding letters of credit. At September 30, 2007, the Company had
outstanding letters of credit related to the purchase of eligible inventory
of
approximately $745,000, and other outstanding letters of credit of approximately
$571,000.
Contractual
Obligations
Certain
of our facilities and equipment are leased under noncancelable operating and
capital leases. Additionally, as discussed below, we have certain long-term
and
short-term indebtedness. The following is a schedule, by fiscal year, of future
minimum rental payments required under current operating, capital leases and
debt repayment requirements as of September 30, 2007:
|
|
Payment
Due By Period (In thousands)
|
|
Contractual Obligations
|
|
Total
|
|
3 Mos. Ended
Dec. 31, 2007
|
|
1-3 Years
|
|
4-5 Years
|
|
More than
5 Years
|
|
Operating
Lease Obligations
|
|
$
|
11,435
|
|
$
|
494
|
|
$
|
5,202
|
|
$
|
2,409
|
|
$
|
3,330
|
|
Capital
Lease Obligations
|
|
|
5,253
|
|
|
105
|
|
|
1,329
|
|
|
948
|
|
|
2,871
|
|
Convertible
Notes due December 7, 2011
|
|
|
28,880
|
|
|
—
|
|
|
—
|
|
|
28,880
|
|
|
—
|
|
Note
Payable to Landlord
|
|
|
158
|
|
|
6
|
|
|
125
|
|
|
27
|
|
|
—
|
|
Interest
on Long-term Debt
|
|
|
6,401
|
|
|
722
|
|
|
4,332
|
|
|
1,347
|
|
|
—
|
|
Interest
on Note Payable to Landlord
|
|
|
22
|
|
|
2
|
|
|
19
|
|
|
1
|
|
|
—
|
|
Severance
Obligations
|
|
|
10
|
|
|
10
|
|
|
—
|
|
|
—
|
|
|
—
|
|
Total
|
|
$
|
52,159
|
|
$
|
1,339
|
|
$
|
11,007
|
|
$
|
33,612
|
|
$
|
6,201
|
|
Such
table excludes any obligation for leasehold improvements beyond the landlord’s
contribution.
Long-Term
Debt, Including Current Installments
On
December 8, 2006, the Company entered into a note purchase agreement for the
sale of $28,880,000 of 5% convertible subordinated notes due December 7, 2011
(the “5% Convertible Notes”). The 5% Convertible Notes are not registered under
the Securities Act of 1933, as amended. The Company has agreed to register
the
shares of the Company’s common stock acquirable upon conversion of the 5%
Convertible Notes, which may include an additional number of shares of common
stock issuable on account of adjustments of the conversion price under the
5%
Convertible Notes. The Company filed a registration statement with respect
to
the shares acquirable upon conversion of the 5% Convertible Notes (the
“Underlying Shares”) on January 9, 2007, and expects to file Amendment No.
1 thereof in November 2007. The registration statement has not been declared
effective.
The
5%
Convertible Notes bear interest at the rate of 5% per annum, payable in cash
semiannually on June 30 and December 31 of each year, commencing June 30, 2007.
For the three and nine months ended September 30, 2007, the Company recorded
interest expense relating to the 5% Convertible Notes of approximately $361,000
and approximately $1,082,000, respectively.
At
the
date of issuance, the 5% Convertible Notes were convertible at the rate of
$4.75
per share, subject to an adjustment for certain anti-dilution provisions. At
the
original conversion price at December 31, 2006, the number of Underlying Shares
was 6,080,000. Since the conversion price was above the market price on the
date
of issuance, there was no beneficial conversion. On January 8, 2007 and January
23, 2007, in conjunction with common stock issuances related to two acquisitions
(see Note 2, “Acquisitions”), the conversion price was adjusted to $4.6706, and
the number of Underlying Shares was thereby increased to 6,183,359, pursuant
to
the anti-dilution provisions applicable to the 5% Convertible Notes. On May
15,
2007 as a result of the issuance of an additional 68,981 shares of common stock
to the Twincraft sellers on account of upward adjustments to the Twincraft
purchase price, and the surrender to the Company of 45,684 shares of common
stock by Regal Medical Supply, LLC, on account of downward adjustments in the
Regal purchase price, the conversion price under the 5% Convertible Notes was
reduced to $4.6617, and the number of Underlying Shares was increased to
6,195,165 shares. This resulted in a debt discount of $476,873, which is
amortized over the term of the 5% Convertible Notes and is recorded as interest
expense in the consolidated statements of operations. The charge to interest
expense relating to the debt discount for the three and nine months ended
September 30, 2007 was approximately $22,000 and approximately $64,000,
respectively. The principal of the 5% Convertible Notes is due on December
7,
2011, subject to the earlier call of the 5% Convertible Notes by the Company,
as
follows: (i) the 5% Convertible Notes may not be called prior to December 7,
2007; (ii) from December 7, 2007, through December 7, 2009, the 5% Convertible
Notes may be called and redeemed for cash, in the amount of 105% of the
principal amount of the 5% Convertible Notes (plus accrued but unpaid interest,
if any, through the call date); (iii) after December 7, 2009, the 5% Convertible
Notes may be called and redeemed for cash in the amount of 100% of the principal
amount of the 5% Convertible Notes (plus accrued but unpaid interest, if any,
through the call date); and (iv) at any time after December 7, 2007, if the
closing price of the common stock of the Company on the NASDAQ (or any other
exchange on which the Company’s common stock is then traded or quoted) has been
equal to or greater than $7.00 per share for 20 of the preceding 30 trading
days
immediately prior to the Company’s issuing a call notice, then the 5%
Convertible Notes shall be mandatorily converted into common stock at the
conversion price then applicable. The Company held a Special Meeting of
Stockholders on April 19, 2007, at which the Company’s stockholders approved the
issuance by the Company of the Underlying Shares.
In
the event of a default on the 5% Convertible Notes, the due date of the 5%
Convertible Notes may be accelerated if demanded by holders of at least 40%
of
the 5% Convertible Notes, subject to a waiver by holders of at least 51% of
the
5% Convertible Notes if the Company pays all arrearages of interest on the
5%
Convertible Notes.
The
payment of interest and principal of the 5% Convertible Notes is subordinate
to
the Company’s presently existing capital lease obligation, in the amount of
$2,700,000, excluding current installments, as of September 30, 2007, and the
Company’s obligations under the Credit Facility. The 5% Convertible Notes would
also be subordinated to any additional debt which the Company may incur
hereafter for borrowed money, or under additional capital lease obligations,
obligations under letters of credit, bankers’ acceptances or similar credit
transactions (see Note 6, “Credit Facility”).
In
connection with the sale of the 5% Convertible Notes, the Company paid a
commission of $1,060,000 based on a rate of 4% of the amount of 5% Convertible
Notes sold, excluding the 5% Convertible Notes sold to members of the Board
of
Directors and their affiliates, to Wm Smith & Co., who served as placement
agent in the sale of the 5% Convertible Notes. The total cost of raising these
proceeds was $1,338,018, which will be amortized through December 7, 2011,
the
due date for the payment on the 5% Convertible Notes. The amortization of these
costs for the three and nine months ended September 30, 2007 was $66,779 and
$196,513, respectively, and is recorded as interest expense in the consolidated
statements of operations.
On
October 31, 2001, the Company completed the sale in a private placement, of
$14,589,000 principal amount of its 4% convertible subordinated notes due and
paid in full, plus accrued interest, on August 31, 2006 (the “4% Convertible
Notes”). The cost of raising these proceeds was $920,933, which was amortized
through August 31, 2006. The amortization of these costs for the three and
nine
months ended September 30, 2006 was $31,963 and $127,853, respectively, and
were
included in interest expense in the consolidated statements of operations.
Interest expense on the 4% Convertible Notes for the three and nine months
ended
September 30, 2006 was $96,260 and $385,040, respectively.
Recently
Issued Accounting Pronouncements
On
September 15, 2006, the FASB issued SFAS No. 157, “Fair Value Measurements”.
SFAS No. 157 is effective for fiscal years beginning after November 15, 2007,
and interim periods within those fiscal years. SFAS No. 157 provides guidance
related to estimating fair value and requires expanded disclosures. The standard
applies whenever other standards require (or permit) assets or liabilities
to be
measured at fair value. The standard does not expand the use of fair value
in
any new circumstances. The Company is evaluating SFAS No. 157 and its impact
on
the Company’s consolidated financial statements, but it is not expected to have
a significant impact.
On
February 22, 2007, the FASB issued SFAS No. 159, "The Fair Value Option for
Financial Assets and Financial Liabilities." This statement gives entities
the
option to carry most financial assets and liabilities at fair value, with
changes in fair value recorded in earnings. This statement, which will be
effective in the first quarter of fiscal 2009, is not expected to have a
material impact on the Company’s consolidated financial position or results of
operations.
Certain
Factors That May Affect Future Results
Information
contained or incorporated by reference in the quarterly report on
Form 10-Q, in other SEC filings by the Company, in press releases, and in
presentations by the Company or its management, contains “forward-looking
statements” within the meaning of the Private Securities Litigation Reform Act
of 1995 which can be identified by the Company of forward-looking terminology
such as “believes,” “expects,” “plans,” “intends,” “estimates,” “projects,”
“could,” “may,” “will,” “should,” or “anticipates” or the negative thereof,
other variations thereon or comparable terminology or by discussions of
strategy. No assurance can be given that future results covered by the
forward-looking statements will be achieved. Such forward looking statements
include, but are not limited to, those relating to the Company’s financial and
operating prospects, future opportunities, the Company’s acquisition strategy
and ability to integrate acquired companies and assets, outlook of customers,
and reception of new products, technologies, and pricing. In addition, such
forward-looking statements involve known and unknown risks, uncertainties,
and
other factors including those described from time to time in the Company’s
Registration Statement on Form S-3, its most recent Form 10-K and
10-Q’s and other Company filings with the Securities and Exchange Commission
which may cause the actual results, performance or achievements by the Company
to be materially different from any future results expressed or implied by
such
forward-looking statements. Also, the Company’s business could be materially
adversely affected and the trading price of the Company’s common stock could
decline if any such risks and uncertainties develop into actual events. The
Company undertakes no obligation to publicly update or revise forward-looking
statements to reflect events or circumstances after the date of this
Form 10-Q or to reflect the occurrence of unanticipated
events.