NOTES TO FINANCIAL STATEMENTS
(UNAUDITED)
1. Summary of Significant Accounting and Reporting Policies
Basis of Presentation
The accompanying unaudited
financial statements of Allied Healthcare Products, Inc. (the “Company”) have been prepared in accordance with the
instructions for Form 10-Q and do not include all of the information and disclosures required by accounting principles generally
accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments, consisting
only of normal recurring adjustments considered necessary for a fair presentation, have been included. Operating results for any
quarter are not necessarily indicative of the results for any other quarter or for the full year. These statements should be read
in conjunction with the financial statements and notes to the financial statements thereto included in the Company’s Annual
Report on Form 10-K for the year ended June 30, 2015.
Recently Issued Accounting Guidance
In May 2014, the Financial
Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU” or “Update”)
No. 2014-09, “Revenue from Contracts with Customers.” This ASU is a comprehensive new revenue recognition model that
requires a company to recognize revenue to depict the transfer of goods or services to a customer at an amount that reflects the
consideration it expects to receive in exchange for those goods or services. This ASU is effective for annual reporting periods
beginning after December 15, 2016 and early adoption is not permitted. On July 9, 2015 the FASB voted to defer the effective date
of this standard by one year to December 15, 2017 for the interim and annual reporting periods beginning after that date and permitted
early adoption of the standard, but not before the original effective date of December 15, 2016. Companies may use either a full
retrospective or modified retrospective approach to adopt this ASU. We are currently evaluating which transition approach to use
and the full impact this ASU will have on our future financial statements.
In August 2014, the
FASB issued ASU No. 2014-15, to communicate amendments to FASB Account Standards Codification Subtopic 205-40, “Disclosure
of Uncertainties about an Entity’s Ability to Continue as a Going Concern.” The ASU requires management to evaluate
relevant conditions, events and certain management plans that are known or reasonably knowable as of the evaluation date when
determining whether substantial doubt about an entity’s ability to continue as a going concern exists. Management will be
required to make this evaluation for both annual and interim reporting periods. Management will have to make certain disclosures
if it concludes that substantial doubt exists or when it plans to alleviate substantial doubt about the entity’s ability
to continue as a going concern. The standard is effective for annual periods ending after December 15, 2016 and for interim reporting
periods starting in 2017. Early adoption is permitted. We currently believe there will be no impact on our financial statement
disclosures.
In April 2015, the
FASB issued ASU No. 2015-03, “Interest – Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of
Debt Issuance Costs”. This ASU requires companies to present debt issuance costs as a direct deduction from the carrying
value of that debt liability. ASU 2015-03 does not impact the recognition and measurement guidance for debt issuance costs.
This ASU was further amended by ASU No. 2015-15, “Interest-Imputation of Interest” to provide guidance with respect
to debt issuance costs associated with line-of-credit arrangements. These ASUs are effective for annual reporting periods beginning
after December 15, 2015 and early adoption is permitted. Accordingly, we will adopt this ASU on July 1, 2016. When implementing
this ASU companies are required to use a retrospective approach and we are currently evaluating the impact to our future financial
statements.
In July 2015, the
FASB issued ASU No. 2015-11 to simplify the subsequent measurement of inventory. Under this new standard, an entity should measure
inventory at the lower of cost and net realizable value. Net realizable value is the estimated selling price in the ordinary course
of business, less reasonably predictable costs of completion, disposal, and transportation. The guidance is effective for fiscal
years, and interim periods within those fiscal years, beginning after December 15, 2016. The amendments in this guidance should
be applied prospectively with earlier application permitted as of the beginning of an interim or annual reporting period. The
Company is currently evaluating the impact to our future financial statements.
In November 2015, the
FASB issued ASU 2015-17, Balance Sheet Classification of Deferred Taxes (Topic 740). This update requires that entities with a
classified balance sheet present all deferred tax assets and liabilities as noncurrent. This update is effective for annual and
interim periods for fiscal years beginning after December 15, 2016, which will require us to adopt these provisions in the first
quarter of fiscal 2018. Early adoption is permitted for financial statements that have not been previously issued. This update
can be applied on either a prospective or retrospective basis. We do not expect the adoption of this update to have a material
impact on our financial statements.
In February 2016, the FASB issued ASU No.
2016-02, “Leases (Topic 842),” which requires lessees to recognize a right-of-use asset and lease liability for all
leases with terms of more than 12 months. Recognition, measurement and presentation of expenses will depend on classification as
a finance or operating lease. ASU 2016-02 is effective for the Company on July 1, 2020. The Company is currently evaluating the
impact to our future financial statements.
In March 2016, the
FASB issued ASU 2016-08, “Revenue from Contracts with Customers (Topic 606) Principal versus Agent Considerations (Reporting
Revenue Gross versus Net),” (“ASU 2016-08”). ASU 2016-08 further clarifies principal and agent relationships
within ASU 2014-09. Similar to ASU 2014-09, the effective date will be the first quarter of fiscal year 2019 with early adoption
permitted in the first quarter of fiscal year 2018. The Company is evaluating the impact that adoption of this new standard will
have on its financial statements.
In March 2016, the
FASB issued ASU 2016-09, “Compensation-Stock Compensation (Topic 718), Improvements to Employee Share-Based Payment Accounting,”
(“ASU 2016-09”). ASU 2016-09 is intended to simplify several aspects of accounting for share-based payment awards.
The effective date will be the first quarter of fiscal year 2018, with early adoption permitted. The Company is evaluating the
impact that adoption of this new standard will have on its financial statements.
In April 2016, the
FASB issued ASU 2016-10, “Revenue from Contracts with Customers (Topic 606), Identifying Performance Obligations and Licensing,”
(“ASU 2016-10”). The amendments in ASU 2016-10 are expected to reduce the cost and complexity of applying the
guidance on identifying promised goods or services in contracts with customers and to improve the operability and understandability
of licensing implementation guidance related to the entity's intellectual property. Similar to ASU 2014-09, the effective
date will be the first quarter of fiscal year 2019 with early adoption permitted in the first quarter of fiscal year 2018.
The Company is evaluating the impact that adoption of this new standard will have on its financial statements.
Fair Value of Financial Instruments
The Company’s
financial instruments consist of cash and cash equivalents, accounts receivable and accounts payable. The carrying amounts for
cash and cash equivalents, accounts receivable and accounts payable approximate their fair value due to the short maturity of
these instruments.
2. Inventories
Inventories are comprised as follows:
|
|
March 31, 2016
|
|
|
June 30, 2015
|
|
|
|
|
|
|
|
|
Work-in progress
|
|
$
|
616,878
|
|
|
$
|
545,410
|
|
Component parts
|
|
|
7,575,251
|
|
|
|
7,721,413
|
|
Finished goods
|
|
|
2,310,280
|
|
|
|
2,397,044
|
|
Reserve for obsolete and excess
|
|
|
|
|
|
|
|
|
inventory
|
|
|
(1,460,120
|
)
|
|
|
(1,472,956
|
)
|
|
|
$
|
9,042,289
|
|
|
$
|
9,190,911
|
|
3. Earnings per share
Basic earnings per
share are based on the weighted average number of shares of all common stock outstanding during the period. Diluted earnings per
share are based on the sum of the weighted average number of shares of common stock and common stock equivalents outstanding during
the period. The number of basic and diluted shares outstanding for the three and nine months ended March 31, 2016 and 2015 were
8,027,147.
4. Commitments and Contingencies
Legal Claims
The Company is subject
to various investigations, claims and legal proceedings covering a wide range of matters that arise in the ordinary course of
its business activities. The Company intends to continue to conduct business in such a manner as to avert any FDA action seeking
to interrupt or suspend manufacturing or require any recall or modification of products.
The
Company has recognized the costs and associated liabilities only for those investigations, claims and legal proceedings for which,
in its view, it is probable that liabilities have been incurred and the related amounts are estimable. Based upon information
currently available, management believes that existing accrued liabilities are sufficient.
Stuyvesant Falls
Power Litigation
. The Company is currently involved in litigation with Niagara Mohawk Power Corporation d/b/a National Grid
(“Niagara”), which provides electrical power to the Company’s facility in Stuyvesant Falls, New York, and one
other party. The Company maintains in its defense of the lawsuit that it is entitled to a certain amount of free electricity
based on covenants running with the land which have been honored for more than a century. After the commencement of the litigation,
Niagara began sending invoices to the Company for electricity used at the Company’s Stuyvesant Falls plant. Niagara’s
attempts to collect such invoices were stopped in December 2010 by a temporary restraining order. Among other things, Niagara
seeks as damages the value of electricity received by the Company without charge. The total value of electricity at issue in the
litigation is not known with certainty and Niagara has alleged different amounts of damages. Niagara alleged in its Second Amended
Verified Complaint, dated February 6, 2012, damages of approximately $469,000 in free electricity from May 2003 through May 2010.
Niagara also alleged in its Motion For Summary Judgment, filed on March 14, 2014, damages of approximately $492,000 in free electricity
from May 2010 through the date of the filing. In April 2015, Allied received an invoice for electrical power at the Stuyvesant
Falls plant with an “Amount Due” balance of $696,000 as of March 31, 2015 without any description as to the period
of time covered by the invoice.
The Company filed a Motion for Summary
Judgment on March 14, 2014, seeking dismissal of Niagara’s claims and oral arguments on the motions were held on June 13,
2014. On October 1, 2014, the Court granted the Company’s motion, denied Niagara’s motion and ruled that the Company
is entitled to receive electrical power pursuant to the power covenants. On October 26 and October 30, 2014, Niagara and the other
party filed separate notices of appeal of the Court’s decision. On March 31, 2016 the Supreme Court of New York, Appellate
Division, Third Department reversed the trial court decision and held that the free power covenants are no longer enforceable.
The Company intends to appeal this ruling and exercise all available options to enforce the free power covenants which have been
in place for over 100 years.
The appellate decision terminated the
enforceability of the free power covenants as of March 31, 2016. The appellate decision did not order the Company to pay any amounts
for power consumed prior to such date and the Company believes that it is not liable for any such damages as a result of the appellate
decision. As of March 31, 2016, the Company has not recorded a provision for this matter.
Dräger
Patent Litigation
. On or about October 4, 2013, Dräger Medical GmbH and certain affiliates (the “Dräger Plaintiffs”)
filed a patent infringement lawsuit against the Company in the District of Delaware (the “2013 Dräger Suit”),
asserting that the Company infringes United States Patent Nos. 7,487,776 and 8,286,633 (the “‘633 Patent”),
both protecting particular combinations of carbon dioxide absorption cartridges and adapters which fit on anesthesia machines.
The Dräger Plaintiffs asserted that the Company’s sales of certain models of its Litholyme and Carbolime single-use
carbon dioxide absorption cartridges infringed both patents. The Company answered the Complaint, asserting invalidity of the patents,
non-infringement, and implied license under the doctrine of permissive repair.
On October 25, 2013,
the Dräger Plaintiffs filed a motion for preliminary injunction requesting that the Company be enjoined from selling certain
models of its Litholyme and Carbolime cartridges during the pendency of the litigation. A hearing on the motion for preliminary
injunction was held on February 7, 2014. On March 24, 2014, the Court ruled in Allied’s favor and denied Dräger’s
motion for a preliminary injunction, stating among other things that Dräger had not carried its burden of showing that Allied
had infringed Dräger’s patents. On June 20, 2014, the Company filed a motion seeking summary judgment based on the
repair doctrine, which was the basis for the Court’s denial of Dräger’s motion for preliminary injunction. On
March 27, 2015, the Court granted the Company’s motion for summary judgment of non-infringement. The Dräger Plaintiffs
appealed the Court’s Order granting the motion for summary judgment on April 21, 2015.
On October 13, 2015,
the Dräger Plaintiffs filed a new patent infringement lawsuit (the “2015 Dräger Suit”) against the Company
in the District of Delaware asserting that the Company infringes United States Reissue Patent No. RE45745, a reissue of the ‘633
Patent. The 2015 Dräger Suit alleged that the Company’s sales of the “Dräger Style” models of its
Litholyme and Carbolime single-use carbon dioxide absorption cartridges infringed the claims of the reissued patent.
On January 29, 2016,
the Company and the Dräger Plaintiffs resolved the 2013 Dräger Suit and the 2015 Dräger Suit pursuant to a mutually
satisfactory settlement agreement. The appeal of the 2013 Dräger Suit was dismissed on February 1, 2016 and the 2015 Dräger
Suit was resolved by a consent judgment and permanent injunction on February 12, 2016. The Company was not required to make any
payments under the settlement agreement, however, it discontinued the manufacture of Dräger Style models of its Litholyme
and Carbolime single-use carbon dioxide absorption cartridges as of October 13, 2015. The Company does not believe that this settlement
agreement will have a material effect on its business, financial position, results of operations or cash flows.
Employment Contract
The Company has entered
into an employment contract with its chief executive officer with annual renewals. The contract includes termination without cause
and change of control provisions, under which the chief executive officer is entitled to receive specified severance payments
generally equal to two times ending annual salary if the Company terminates his employment without cause or he voluntarily terminates
his employment with “good reason.” “Good Reason” generally includes changes in the scope of his duties
or location of employment but also includes (i) the Company’s written election not to renew the Employment Agreement and
(ii) certain voluntary resignations by the chief executive officer following a “Change of Control” as defined in the
Agreement.
5. Financing
As of March 31, 2016,
the Company is party to a Loan and Security Agreement, dated November 17, 2009, with Enterprise Bank & Trust (the “Credit
Agreement”) pursuant to which the Company obtained a secured revolving credit facility. Currently, the agreement provides
for borrowing availability of up to $5,000,000 (the “Credit Facility”). The Company’s obligations under the
Credit Facility are secured by certain assets of the Company pursuant to the terms and subject to the conditions set forth in
the Credit Agreement.
The Credit Agreement
was amended on November 9, 2015 extending the maturity date to November 9, 2016. Subject to the conditions and limitations set
forth in the Credit Agreement, the Credit Facility will be available on a revolving basis until it expires on November 9, 2016,
at which time all amounts outstanding under the Credit Facility will be due and payable. Advances under the Credit Facility will
be made pursuant to a Revolving Credit Note (as defined in the Credit Agreement) executed by the Company in favor of Enterprise
Bank & Trust. Such advances will bear interest at a rate equal to 3.50% in excess of the 30-day LIBOR rate. Advances may be
prepaid in whole or in part without premium or penalty.
While the Credit Agreement
provides for stated availability of $5.0 million, in connection with renewal on November 9, 2015, a new covenant was added requiring
the Company to maintain minimum “liquidity” of $1.25 million. Liquidity is defined as the difference between cash
and cash equivalents and the aggregate principal balance of borrowings under the Credit Agreement and is measured at the last
day of each fiscal quarter, commencing on December 31, 2015. Based on the Company’s cash and cash equivalents as of March
31, 2016, the Company would only be permitted to borrow up to $.48 million as of such date. Decreases in the Company’s cash
position will effectively reduce the amount the Company is able to borrow and/or require accelerated repayments.
Under the Credit
Agreement, advances are generally subject to customary borrowing conditions.
The Credit Agreement also contains covenants
with which the Company must comply during the term of the Credit Facility. Among other things, such covenants restrict the Company’s
ability to incur certain additional debt; make specified restricted payments, dividends and capital expenditures; authorize or
issue capital stock; enter into certain transactions with affiliates; consolidate or merge with or acquire another business; sell
certain of its assets or dissolve or wind up the Company. In addition, effective November 9, 2015, the Credit Agreement includes
the minimum liquidity requirement described above. The Credit Agreement also contains certain events of default that are customary
for financings of this type including, without limitation: the failure to pay principal, interest, fees or other amounts when
due; the breach of specified representations or warranties contained in the loan documents; cross-default with certain other indebtedness
of the Company; the entry of uninsured judgments that are not bonded or stayed; failure to comply with the observance or performance
of specified agreements contained in the loan documents; commencement of bankruptcy or other insolvency proceedings; and the failure
of any of the loan documents entered into in connection with the Credit Facility to be in full force and effect. After an event
of default, and upon the continuation thereof, the principal amount of all loans made under the Credit Facility would bear interest
at a rate per annum equal to 4.00% above the otherwise applicable interest rate (provided, that the interest rate may not exceed
the highest rate permissible under law), and the lender would have the option to accelerate maturity and payment of the Company’s
obligations under the Credit Facility.
The 30-day LIBOR rate
was 0.43% on March 31, 2016.
At March 31, 2016,
the Company had no aggregate indebtedness, including capital lease obligations, short-term debt and long term debt.
The Company was in
compliance with all of the covenants associated with the Credit Facility at March 31, 2016.
6. Income
Taxes
The Company accounts
for income taxes under ASC Topic 740: “Income Taxes.” Under ASC 740, the deferred tax provision is determined using
the liability method, whereby deferred tax assets and liabilities are recognized based upon temporary differences between the
financial statement and income tax bases of assets and liabilities using presently enacted tax rates. Valuation allowances are
established when necessary to reduce deferred tax assets to the amounts expected to be realized. In the three and nine months
ended March 31, 2016 the Company recorded the tax benefit of losses incurred in the amount of approximately $233,000 and $660,000,
respectively. As the realization of the tax benefit of the net operating loss is not assured, an additional valuation allowance
of approximately $233,000 and $660,000, net of the effect of the deferred taxes in the amount of $10,000 and ($35,000), for the
three and nine months ended respectively, was also recorded. As a result of the expiration of tax benefits associated with expiring
stock options not previously covered by the valuation allowance, the Company recorded a deferred tax benefit in the amount of
approximately $0 and $124,000 for the three and nine months ended respectively. For the three and nine months ended March 31,
2015, the Company recorded the tax benefit of losses incurred in the amount of $192,000 and $471,000 net of additions to the valuation
allowance of like amounts. The total valuation allowance recorded by the Company as of March 31, 2016 and 2015 was approximately
$1,920,000 and $1,271,000, respectively. To the extent that the Company’s losses continue in future quarters, the
tax benefit of those losses will be subject to a valuation allowance.