UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
(Mark One)
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x
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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
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For the period ended: March 31, 2008
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¨
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TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
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For the transition period from
to
Commission File Number: 0-28260
EP MEDSYSTEMS, INC.
(Exact name of
registrant as specified in its charter)
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New Jersey
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22-3212190
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(State or other jurisdiction of
incorporation or organization)
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(I.R.S. Employer
Identification No.)
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575 Route 73 N. Building D, West Berlin, New Jersey
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08091
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(Address of principal executive offices)
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(Zip Code)
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(856) 753-8533
(Registrant’s telephone number)
Indicate by check mark whether the registrant
(1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
x
Yes
¨
No
Indicate by check mark whether the registrant is a large accelerated filer, accelerated filer or a non-accelerated filer. See definition of “accelerated filer
and large accelerated filer” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
¨
Accelerated filer
¨
Non-accelerated filer
¨
Smaller
reporting company
x
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Exchange Act).
¨
Yes
x
No
APPLICABLE ONLY TO CORPORATE ISSUERS
State the number of shares outstanding of each of the
issuer’s classes of common equity, as of the latest practicable date:
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Class
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Outstanding at May 8, 2008
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Common Stock, without par value
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30,405,236 shares
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EP MEDSYSTEMS, INC. AND SUBSIDIARIES
FORM 10-Q
CONTENTS
2
PART I. FINANCIAL INFORMATION
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Item 1.
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Financial Statements.
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EP MEDSYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
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March 31,
2008
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December 31
2007
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(unaudited)
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ASSETS
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Current assets:
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Cash and cash equivalents
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$
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5,116,513
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$
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5,553,637
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Accounts receivable, net of allowance for doubtful accounts of $109,000, and $107,000 as of March 31, 2008 and December 31, 2007,
respectively
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3,991,696
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4,368,992
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Inventories, net of reserves
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2,534,348
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2,331,567
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Prepaid expenses and other current assets
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489,704
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327,166
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Total current assets
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12,132,261
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12,581,362
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Property, plant and equipment, net
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1,520,573
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1,581,835
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Goodwill
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341,730
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341,730
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Other intangible assets, net
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80,829
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102,293
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Other assets
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112,192
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20,105
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Total assets
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$
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14,187,585
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$
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14,627,325
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LIABILITIES AND SHAREHOLDERS’ EQUITY
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Current liabilities:
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Secured convertible note
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—
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1,998,595
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Secured revolving loan
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1,200,000
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—
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Secured term loan
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1,500,000
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—
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Accounts payable
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2,014,727
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1,684,733
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Accrued expenses
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1,613,799
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2,026,010
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Deferred revenue
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838,607
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814,979
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Total current liabilities
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7,167,133
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6,524,317
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Deferred warranty revenue– non-current
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479,675
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547,034
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Total liabilities
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$
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7,646,808
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$
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7,071,351
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Commitments and contingencies
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—
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—
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Shareholders’ equity:
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Preferred stock, no par value, 5,000,000 shares authorized, no shares issued and outstanding
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—
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—
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Common stock, $.001 stated value, 50,000,000 shares authorized, 30,405,236 issued
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30,406
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30,406
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Additional paid-in capital
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68,594,788
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68,391,581
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Accumulated other comprehensive loss
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(434,038
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)
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(458,494
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)
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Treasury stock, 50,000 shares at cost
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(100,000
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)
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(100,000
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)
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Accumulated deficit
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(61,550,379
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)
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(60,307,519
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)
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Total shareholders’ equity
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6,540,777
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7,555,974
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Total liabilities and shareholders’ equity
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$
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14,187,585
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$
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14,627,325
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The accompanying notes are an integral part of these statements.
3
EP MEDSYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
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For the Three Months Ended
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March 31,
2008
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March 31,
2007
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Net sales
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$
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4,572,008
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$
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3,544,245
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Cost of products sold
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1,275,470
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1,156,762
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Gross profit
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3,296,538
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2,387,483
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Operating costs and expenses:
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Sales and marketing expenses
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2,496,969
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2,310,059
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General and administrative expenses
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970,925
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946,082
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Research and development expenses
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1,063,218
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665,449
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Total operating expenses
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4,531,112
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3,921,590
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Loss from operations
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(1,234,574
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)
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(1,534,107
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)
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Interest and other income
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34,172
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89,791
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Interest expense
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(42,458
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)
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(64,493
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)
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Net loss
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(1,242,860
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)
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(1,508,809
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)
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Basic and diluted loss per share
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$
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(.04
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)
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$
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(.05
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)
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Weighted average shares outstanding used to compute basic and diluted loss per share
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30,405,236
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30,365,236
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The accompanying notes are an integral part of these statements.
4
EP MEDSYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
FOR THE THREE MONTHS ENDED MARCH 31, 2008 (unaudited)
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Common
Stock
Shares
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Common
Stock
Amount
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Additional
Paid-in
Capital
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Accumulated
Other
Comprehensive
Loss
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Treasury
Stock
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Accumulated
Deficit
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|
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Total
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Balance, December 31, 2007
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30,405,236
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$
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30,406
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$
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68,391,581
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$
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(458,494
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)
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$
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(100,000
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)
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$
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(60,307,519
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)
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$
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7,555,974
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Share-based compensation
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—
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—
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203,207
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—
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—
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—
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203,207
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Foreign currency translation
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—
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—
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—
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24,456
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—
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—
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24,456
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Net loss
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—
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—
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|
|
—
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|
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—
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—
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|
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(1,242,860
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)
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|
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(1,242,860
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)
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Balance, March 31, 2008
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30,405,236
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$
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30,406
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$
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68,594,788
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$
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(434,038
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)
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$
|
(100,000
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)
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$
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(61,550,379
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)
|
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6,540,777
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|
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The accompanying notes are an integral part of this statement.
5
EP MEDSYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
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For the Three Months Ended
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March 31,
2008
|
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March 31,
2007
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Cash flows from operating activities:
|
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|
|
|
|
|
|
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Net loss
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$
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(1,242,860
|
)
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$
|
(1,508,809
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)
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Adjustments to reconcile net loss to net cash (used in) provided by operating activities:
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|
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Depreciation and amortization
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176,945
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238,223
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Accretion of note discount
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1,405
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2,278
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Amortization of beneficial conversion feature
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2,934
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4,767
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Share-based compensation
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203,207
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214,002
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Bad debt recovery
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(730
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)
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(91,000
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)
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Changes in assets and liabilities:
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|
|
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Decrease in accounts receivable
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378,025
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1,491,877
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Increase in inventories
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(253,417
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)
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(214,318
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)
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(Increase) decrease in prepaid expenses and other assets
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(257,559
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)
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6,969
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Increase in accounts payable
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329,994
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16,604
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Decrease in accrued expenses and deferred revenue
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(455,941
|
)
|
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(112,736
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)
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|
|
|
|
|
|
|
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Net cash (used in) provided by operating activities
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$
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(1,117,997
|
)
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$
|
47,857
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|
|
|
|
|
|
|
|
|
|
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Cash flows from investing activities:
|
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|
|
|
|
|
|
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Capital expenditures
|
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|
(43,583
|
)
|
|
|
(60,605
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)
|
|
Patent costs
|
|
|
—
|
|
|
|
(25,438
|
)
|
|
|
|
|
|
|
|
|
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Net cash used in investing activities
|
|
$
|
(43,583
|
)
|
|
$
|
(86,043
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)
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from financing activities:
|
|
|
|
|
|
|
|
|
|
Borrowings under secured term loan
|
|
|
1,500,000
|
|
|
|
—
|
|
|
Borrowings under revolving credit agreement
|
|
|
1,200,000
|
|
|
|
—
|
|
|
Repayment of secured convertible debt
|
|
|
(2,000,000
|
)
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash provided by financing activities
|
|
$
|
700,000
|
|
|
$
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Effect of exchange rate changes
|
|
|
24,456
|
|
|
|
4,236
|
|
|
|
|
|
|
Net decrease in cash and cash equivalents
|
|
|
(437,124
|
)
|
|
|
(33,950
|
)
|
|
Cash and cash equivalents, beginning of period
|
|
|
5,553,637
|
|
|
|
7,743,239
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents, end of period
|
|
$
|
5,116,513
|
|
|
$
|
7,709,289
|
|
|
|
|
|
|
|
|
|
|
|
|
Supplemental cash flow information:
|
|
|
|
|
|
|
|
|
|
Cash paid for interest
|
|
$
|
35,269
|
|
|
$
|
49,950
|
|
|
|
|
|
|
|
|
|
|
|
The accompanying notes are an integral part of these statements.
6
EP MEDSYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
Note 1. Basis of Presentation
General
The terms “we,” “our,” “us,” “Company” and “EP MedSystems” refer to EP MedSystems, Inc., a New Jersey
corporation, and its subsidiaries unless the context suggests otherwise.
The accompanying unaudited consolidated financial statements have
been prepared in accordance with generally accepted accounting principles in the United States of America for interim financial information and in accordance with the instructions to Form 10-Q. Accordingly, they do not include all of the financial
information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (including normal recurring adjustments) considered necessary for a fair presentation
have been included.
The preparation of financial statements in conformity with accounting principles generally accepted in the United
States requires management to make estimates and assumptions that affect the reported amount of assets and liabilities, the disclosure of contingent liabilities, and the reported amounts of revenues and expenses. Significant estimates affecting
amounts reported or disclosed in the financial statements include allowances for doubtful accounts receivable and sales returns, net realizable value of inventories, estimates of future cash flows associated with long-lived asset valuations,
depreciation and amortization periods for long-lived assets and fair value estimates of stock-based compensation awards, among others. These estimates are based on historical experience and on various other assumptions that are believed to be
reasonable under the current circumstances. Actual results could differ from these estimates.
The results of operations for the respective
interim periods are not necessarily indicative of the results to be expected for the full year. The accompanying unaudited consolidated financial statements should be read in conjunction with the audited consolidated financial statements and the
notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2007 filed with the Securities and Exchange Commission.
Merger Agreement
On April 8, 2008, we entered into an Agreement and Plan of Merger (the
“Merger Agreement”) with St. Jude Medical, Inc. (St. Jude Medical”) pursuant to which St. Jude Medical will acquire all of the issued and outstanding stock of the Company at a price of $3.00 per share, for a total consideration of
approximately $92 million. The Merger Agreement provides that the Company’s shareholders will have the opportunity to elect to receive, in exchange for each share of Company common stock they own, either (i) a cash payment in the amount of
$3.00 or (ii) an amount of common stock of St. Jude Medical equal to $3.00 divided by the average closing sale price of one share of St. Jude Medical common stock on the NYSE Composite Transactions reporting system for each of the ten
(10) trading days ending on the second trading day prior to the closing date of the Merger. Of the consideration payable to holders of outstanding shares of common stock of the Company, no more than 60% of such consideration will consist of
cash and no more than 40% will consist of shares of St. Jude Medical common stock, as determined as set forth in the Merger Agreement.
The
closing of the transaction is subject to customary conditions, including (i) the approval and adoption by the requisite vote of the holders of the outstanding shares of common stock of the Company, (ii) authorization of the listing of St.
Jude Medical common stock for trading on the NYSE, (iii) absence of a Material Adverse Event (as defined in the Agreement) and (iv) certain regulatory approvals. Additionally, consummation of the Merger is also subject to conditions
requiring (1) that other parties to certain contracts shall not have terminated or repudiated, or given notice of an intent to terminate or repudiate, any such contract and (2) that the US Food and Drug Administration (“FDA”)
shall not have restricted the Company’s ability to (i) manufacture, market, sell or otherwise distribute any Company products previously approved or cleared by the FDA for marketing and sale or (ii) obtain approval or clearance to
market and sell any products which have not yet been approved or cleared for marketing and sale by the FDA.
Cash and cash equivalents
Our cash and cash equivalents were approximately $5.1 million and $5.6 million as of March 31, 2008 and December 31, 2007, respectively.
On February 28, 2008, the Company completed funding on a $3 million secured loan facility with an asset-based lender. The loan arrangement includes a $1.5 million asset based revolving credit agreement and a $1.5 million term loan, each with a
three year term. The Company used proceeds from the facility to pay off its $2.0 million convertible debt which matured on February 28, 2008.
7
Based upon our current operating plans and projections, we believe that our existing capital resources,
comprised of cash on hand and the remaining borrowing availability under the loan arrangement, will be sufficient to meet our anticipated capital needs through the end of December 2008 although there can be no assurance of this as this estimate is
based upon a number of assumptions, which may not hold true.
The failure to complete of the merger with St. Jude Medical may impact the
Company’s future liquidity and capital requirements. In that event, the Company may seek to raise funds to meet our long term capital needs through equity or debt financings, collaborative or other arrangements with third parties or through
other sources of financing. There can be no assurance that such funds will be available on terms favorable to the Company, if at all. Also, there can be no assurance, assuming we successfully raise additional funds, that we will achieve positive
cash flow. If we are not able to secure additional funding, we may be required to scale back our sales and marketing efforts, research and development programs and general and administrative activities and possibly seek to sell or license rights to
our products to third parties.
Note 2. Inventories
Inventories are valued at the lower of cost or market with cost being determined on a first-in, first-out basis. Inventories consist of the following at March 31, 2008 and December 31, 2007:
|
|
|
|
|
|
|
|
|
|
|
|
|
March 31,
2008
(unaudited)
|
|
|
December 31,
2007
|
|
|
Raw materials
|
|
$
|
1,229,000
|
|
|
$
|
1,136,000
|
|
|
Work in process
|
|
|
319,000
|
|
|
|
119,000
|
|
|
Finished goods
|
|
|
1,089,000
|
|
|
|
1,218,000
|
|
|
Reserve for obsolescence
|
|
|
(103,000
|
)
|
|
|
(142,000
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
2,534,000
|
|
|
$
|
2,331,000
|
|
|
|
|
|
|
|
|
|
|
|
Note 3. Notes payable
On February 28, 2008, the Company entered into a $3 million secured Loan Agreement (the “Keltic Loan Agreement”) with Keltic Financial Partners L.P. (“Keltic”), which included (i) a
$1,500,000 revolving loan (the “Revolving Loan”), and (ii) a $1,500,000 term loan (the “Term Loan”). The loans are secured by a first lien on all assets of the Company, including intellectual property. The Company used
proceeds of the loan to repay its $2 million secured convertible note which matured on February 28, 2008.
The Revolving Loan bears
interest at the greater of: (a) the prime rate plus 1.75% or (b) eight percent (8.00%). The Term Loan bears interest at the greater of: (a) the prime rate plus 2.00% or (b) eight and one-quarter percent (8.25%). The maturity date
of the Revolving Loan is February 28, 2011. The Term Loan requires principal payments of $25,000 per month for thirty-six (36) months followed by a balloon payment of $600,000 on February 28, 2011, unless the Revolving Loan is
extended, in which case the Company will continue to pay $25,000 per month through February 28, 2013. On and after the occurrence of an Event of Default (as defined in the Keltic Loan Agreement), all principal, interest and all other amounts
due under the Term and Revolving Loans may be accelerated at the sole option of Keltic and the interest rate on the loans may be increased three and one-half percent (3.5%) per annum.
In conjunction with this transaction, the Company issued Keltic a warrant to purchase 25,000 shares of the Company’s Common Stock at $2.50 per share
exercisable for a five year period. The fair value of these warrants was immaterial to the financial statements.
The Company has
classified its debt which was refinanced in February 2008 as short term debt since the Keltic loan contains a subjective acceleration clause and requires the use of a lock-box for collection of accounts receivable.
Note 4. Shareholders’ Equity
Preferred Stock
EP MedSystems is authorized to issue 5,000,000 shares of undesignated preferred stock, no par value per share. The Board of Directors has the authority
to issue preferred stock in one or more classes, to fix the number of shares constituting a class and the stated value thereof, and to fix the terms of any such class, including dividend rights, dividend rates, conversion or exchange rights, voting
rights, rights and terms of redemption, the redemption price and the liquidation preference of such shares or class.
8
Common Stock
At the Company’s Annual Meeting of Shareholders held on September 12, 2007, the shareholders approved an amendment to its Certificate of Incorporation to increase the authorized number of shares of common stock from 40,000,000
shares to 50,000,000 shares. The Company’s common stock has no par value, $.001 stated value per share, and a total of 30,405,236 shares were issued and 50,000 shares were held in Treasury Stock at both March 31, 2008 and December 31,
2007.
Note 5. Stock Based Compensation
Effective January 1, 2006, the Company adopted FASB Statement No. 123R, “Shared-Based Payment”. Statement 123R requires that the compensation cost relating to share-based payment transactions be recognized in financial
statements. That cost is measured based on the fair value of the equity or liability instruments issued.
The Company currently has five
stock-based employee compensation plans and stock options issued outside of those plans. Stock options issued under the plans become exercisable over specified periods, generally within five years from the date of grant and generally expire ten
years from the grant date. Share-based compensation of $203,000 and $214,000 or $0.01 per share was recognized for the three months ended March 31, 2008 and 2007, respectively.
Information relating to stock options for the three months ended March 31, 2008 is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
Number of
Option
|
|
|
Options
Price
Range
|
|
Weighted
Average
Exercise Price
|
|
Outstanding at December 31, 2007
|
|
3,624,658
|
|
|
$1.19 - $4.25
|
|
$
|
2.15
|
|
|
|
|
|
|
|
|
|
|
|
Granted
|
|
130,000
|
|
|
$1.52 - $1.93
|
|
$
|
1.60
|
|
Exercised
|
|
—
|
|
|
—
|
|
|
—
|
|
Forfeited/Expired
|
|
(107,500
|
)
|
|
$1.77 - $2.10
|
|
$
|
2.07
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding at March 31, 2008
|
|
3,647,158
|
|
|
$1.19 - $4.25
|
|
$
|
2.13
|
|
|
|
|
|
|
|
|
|
|
|
Exercisable at March 31, 2008
|
|
1,639,258
|
|
|
$1.19 - $4.25
|
|
$
|
2.56
|
|
|
|
|
|
|
|
|
|
|
The following table provides the weighted average fair value of stock options granted to employees
during the three months ended March 31, 2008 and 2007 and the related weighted average assumptions used in the Black-Scholes model:
|
|
|
|
|
|
|
|
|
|
|
|
|
March 31,
|
|
|
|
|
2008
|
|
|
2007
|
|
|
Fair value of options granted
|
|
$
|
172,000
|
|
|
$
|
207,000
|
|
|
Assumptions used:
|
|
|
|
|
|
|
|
|
|
Expected life (years)
|
|
|
10 years
|
|
|
|
10 years
|
|
|
Risk-free interest rate
|
|
|
2.88
|
%
|
|
|
4.58
|
%
|
|
Volatility
|
|
|
81
|
%
|
|
|
82
|
%
|
|
Dividend yield
|
|
|
0
|
%
|
|
|
0
|
%
|
|
Weighted average fair value of options granted during the year
|
|
$
|
1.32
|
|
|
$
|
1.20
|
|
Expected life
: Management uses historical information to estimate expected forfeitures to estimate the
expected term of options within the valuation model. The expected term of awards represents the period of time that options granted are expected to be outstanding. Compensation cost is recognized using a straight-line method over the vesting or
service period and is net of estimated forfeitures.
Risk-free interest rate
: The risk-free interest rate for periods within the expected life of
the option is based on the U.S. Treasury yield curve in effect at the time of grant.
Volatility
: Expected volatility is based on the historical
volatility of the price of shares of the Company’s common stock over the past approximately 10 years.
Dividend yield
: The Company does not
anticipate paying any cash dividends in the foreseeable future and therefore a dividend yield of zero is assumed.
9
Note 6. Industry Segment and Geographic Information
EP MedSystems manages its business based on one reportable segment, the manufacture and sale of cardiac electrophysiology products. EP MedSystems’
chief operating decision-makers use consolidated results to make operating and strategic decisions. The following table sets forth product sales by geographic region for the three months ended March 31, 2008 and 2007.
|
|
|
|
|
|
|
|
|
|
|
For The Three Months
Ended March 31,
|
|
|
|
2008
|
|
2007
|
|
United States
|
|
$
|
3,510,000
|
|
$
|
2,478,000
|
|
Europe/Middle East
|
|
|
612,000
|
|
|
764,000
|
|
Asia and Pacific Rim
|
|
|
450,000
|
|
|
302,000
|
|
|
|
|
|
|
|
|
|
|
|
$
|
4,572,000
|
|
$
|
3,544,000
|
|
|
|
|
|
|
|
|
EP MedSystems’ long-lived assets are primarily located in the United States. No customer
accounted for more than 10% of the Company’s sales for the three months ended March 31, 2008 or 2007. No customer accounted for more than 10% of the gross outstanding accounts receivables at March 31, 2008.
Net sales for the three months ended March 31, 2008 were billed in two currencies: $4,380,000 and $3,298,000 in U.S. dollars and the equivalent of
$192,000 and $246,000 in Euros during the three months ended March 31, 2008 and 2007 respectively. Management has determined the impact of foreign currency risk on sales to be minimal since a majority of sales are billed in U.S. dollars. EP
MedSystems does incur translation gains and losses, which are recorded in shareholders’ equity. Cumulative translation losses amounted to approximately $434,000 as of March 31, 2008. In addition, EP MedSystems had not entered into any
derivative financial instruments for hedging or other purposes.
Note 7. Net Loss Per Share
Basic net loss per share is computed using the weighted-average number of shares of common stock outstanding. Diluted net loss per share does not differ
from basic net loss per share since potential shares of common stock from the exercise of stock options and warrants are anti-dilutive for all periods presented. Accordingly, potential common shares of approximately 3,930,000 and 4,361,000 for the
three months ending March 31, 2008 and 2007, respectively, have been excluded from the diluted per share calculation.
Note 8. Comprehensive
Income/Loss
For the three months ended March 31, 2008 and 2007, EP MedSystems’ comprehensive loss consisted of net loss and
foreign currency translation adjustments resulting from our UK and French subsidiaries. The comprehensive losses for the three months ended March 31, 2008 and 2007 were approximately $1,218,000 and $1,505,000, respectively.
Note 9. Income Taxes
EP MedSystems accounts for
income taxes in accordance with the provisions of Statement of Financial Accounting Standards No. 109, “Accounting for Income Taxes” (SFAS No. 109”). SFAS 109 requires the Company to recognize income tax benefits for the
loss carryforwards, which have not previously been recorded. At March 31, 2008, a valuation allowance has been recognized to offset all deferred tax assets related to these carryforwards. At March 31, 2008, the Company had approximately
$55,000,000 of federal net operating loss carryforwards available to offset future income. The federal carryforwards expire between 2009 and 2027. Due to ownership changes that occurred, as defined by Section 382 of the Internal Revenue Code,
EP MedSystems may be limited in the use of net operating losses generated prior to the changes in ownership in each year following the change in ownership. Additionally, EP MedSystems may have experienced subsequent changes in ownership, as defined
by Section 382, resulting in additional limitations in EP MedSystems’ ability to utilize certain net operating losses.
Note 10. Recently
Issued Accounting Standards
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (SFAS No. 157).
SFAS No. 157 establishes a framework for measuring fair value, clarifies the definition of fair value, and requires additional disclosures about fair-value measurements. SFAS No. 157 applies only to fair value measurements that are already
required or permitted by other accounting standards (except for measurements of share-based payments). SFAS No. 157, as issued, is effective for fiscal years beginning after November 15, 2007 except that FASB Staff Position 157-2 delayed
the effective date of SFAS 157 until fiscal years beginning after November 15, 2008 for nonfinancial assets and liabilities. The adoption of SFAS No.
10
157 for financial assets and liabilities did not have a material impact on the Company’s consolidated financial position or results of operations. The
Company does not believe that the adoption of SFAS No. 157 for nonfinancial assets and liabilities will have a material impact on its consolidated financial position or results of operations.
On February 15, 2007, the FASB issued FASB Statement No. 159, “
The Fair Value Option for Financial Assets
and
Financial
Liabilities
,” (FAS159). The Fair value option established by Statement 159 permits, but does not require, all entities to choose to measure eligible items at fair value at specified election dates. An entity would report unrealized gains
and losses on items for which the fair value option has been elected in earnings at each subsequent reporting date. Statement 159 is effective as of the beginning of an entity’s fiscal year that begins after November 15, 2007. The adoption
of SFAS No. 159 did not have a material impact on the Company’s consolidated financial position or results of operations.
In
December 2007, the FASB issued SFAS No. 141 (revised 2007), “Business Combinations” (“SFAS 141(R)”), which replaces SFAS 141. SFAS 141(R) establishes principles and requirements for how an acquirer in a business combination
recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed and any controlling interest; recognizes and measures the goodwill acquired in the business combination or a gain from a bargain purchase;
and determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. SFAS 141(R) applies prospectively to business combinations for which the acquisition
date is on or after an entity’s fiscal year that begins after December 15, 2008. The Company will assess the impact of SFAS 141(R) if and when a future acquisition occurs.
Note 11. Related Party Transactions
On February 26, 2008, the Board of Directors approved
Senior Management Incentive Agreements with each of two current senior officers (the “2008 Senior Management Incentive Agreements”). Those senior officers are David I. Bruce, President and Chief Executive Officer and James J. Caruso, Chief
Financial Officer and Secretary. The agreements provide that if the senior officer is employed with EP MedSystems immediately prior to a “change of control” (as defined in the agreements) of EP MedSystems, EP MedSystems will pay to each of
the senior officers an amount equal to two times the senior officer’s annual base salary (which excludes any incentive pay, premium pay, commissions, overtime, bonuses and other forms of variable compensation). The agreements also confirm the
policy previously approved by the Company’s Board of Directors that all options to purchase common stock of EP MedSystems granted to its employees (including all senior officers) will vest immediately prior to a change of control. The incentive
agreements also provide that if a senior officer’s benefits under the incentive agreement would result in an Internal Revenue Code Section 280C(b)(1) “parachute payment,” such senior officer will receive an additional amount not
to exceed 20% of the amount of the payments and benefits otherwise payable to the senior officer upon the occurrence of a change in control. All senior officers are employed by EP MedSystems on an “at-will” basis and none of the senior
officers has an employment agreement with EP MedSystems. The terms of Mr. Bruce’s Senior Management Incentive Agreement are consistent with his employment offer letter, previously disclosed by the Company on Form 8-K filed with the
Securities Exchange Commission on August 17, 2006.
Note 12. Commitments and Contingencies
Export Compliance
During the second quarter of
2005, the Company announced it was under investigation by the United States Department of Commerce, the United States Attorney’s Office for the District of New Jersey and the United States Department of the Treasury in connection with the sale
of certain of its products to Iran. In addition, the Company announced the SEC was conducting a confidential, informal inquiry into the Company’s financial and accounting reporting regarding these investigations.
In March of 2006, the U.S. Attorney’s office informed the Company that it would not prosecute the Company in connection with this matter. In the
third quarter of 2006, the Company reached a settlement agreement with the Department of Commerce which required the Company to make a payment of $244,000 without admitting or denying guilt. In the first quarter of 2007, the Company reached a
settlement agreement with the Department of the Treasury which required the Company to make a payment of $33,000 without admitting or denying guilt.
The Company cannot assure that the ongoing informal inquiry by the SEC will not result in other significant costs, fines or penalties that could, in the aggregate, have a material adverse effect on our business,
financial condition, prospects or results of operations. The Company has made no provision for any future costs associated with these investigations or any costs associated with the Company’s defense or negotiations with the SEC entities to
resolve this final outstanding issue. We have not received any communication from the SEC regarding this informal inquiry since February, 2006.
11
Product Field Action
The Company initiated a field action recall for its EP-4 stimulator product in March 2006. This field action consisted of an upgrade of the installed base in a phased process and required us to bring the units
in-house to make certain modifications. During 2006, the Company accrued approximately $256,000 in costs associated with this field action to cover the cost of shipping and modifying the product. Through December 31, 2006, the Company incurred
approximately $184,000 in costs associated with this process. During 2007, the Company spent an additional $43,000 in connection with the recall. The field action recall was completed for all domestic units during 2007 and the $29,000 balance of the
original accrual was reversed during the third quarter of 2007.
As a result of the recall, the FDA performed an inspection of the
Company’s facility and subsequently issued the Company a report containing several observations identified during the course of the audit. In September 2006, the FDA issued a Warning Letter to the Company that identified certain issues
with respect to the Company’s conformity with the FDA’s quality system regulations and certain reporting requirements. The FDA requested a written plan outlining the steps to address the issues identified in the letter. The
Company undertook steps toward addressing the observations from the FDA’s audit of the Company’s facility and has responded to the FDA’s request for a written plan. Failure to promptly address these issues may result in
regulatory action including but not limited to seizure, injunction and/or civil monetary penalties. The Company believes it has fully addressed the concerns of the FDA. In February, 2008, the FDA returned to the Company’s facility to
perform its normal periodic inspection and to confirm our actions with respect to the warning letter. At the conclusion of the inspection, additional observations were issued to the Company. The Company has taken actions to correct these items and
communicated these to the FDA.
Income Taxes
The Company is subject to U.S. federal income tax, foreign tax liabilities as well as income tax of multiple state jurisdictions. The Company has substantial federal and New Jersey state net operating losses. There
are no tax years by any jurisdiction under examination at this time.
On January 1, 2007, the Company adopted the provisions of
Financial Accounting Standards Board (“FASB”) Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”), an interpretation of FASB Statement No. 109, “Accounting for Income
Taxes.” FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The interpretation requires that the
Corporation recognize the impact of a tax position in the financial statements if that position is more likely than not of being sustained on audit, based on the technical merits of the position. FIN 48 also provides guidance on derecognition,
classification, interest and penalties, accounting in interim periods and disclosure. In accordance with the provisions of FIN 48, any cumulative effect resulting from the change in accounting principle is to be recorded as an adjustment to the
opening balance of deficit. The adoption of FIN 48 did not result in a material impact on the Company’s financial position or results of operations.
|
Item 2.
|
Management’s Discussion and Analysis of Financial Condition and Results of Operations.
|
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our condensed consolidated
financial statements and the related notes thereto appearing elsewhere in this report and our consolidated financial statements for the year ended December 31, 2007 included in our Annual Report on Form 10-K.
Recent Developments
On April 8, 2008, we
entered into an Agreement and Plan of Merger (the “Merger Agreement”) with St. Jude Medical pursuant to which St. Jude Medical will acquire all of the issued and outstanding stock of the Company at a price of $3.00 per share, for a total
consideration of approximately $92 million. The Merger Agreement provides that the Company’s shareholders will have the opportunity to elect to receive, in exchange for each share of Company common stock they own, either (i) a cash payment
in the amount of $3.00 or (ii) an amount of common stock of St. Jude Medical equal to $3.00 divided by the average closing sale price of one share of St. Jude Medical common stock on the NYSE Composite Transactions reporting system for each of
the ten (10) trading days ending on the second trading day prior to the closing date of the Merger. Of the consideration payable to holders of outstanding shares of common stock of the Company, no more than 60% of such consideration will
consist of cash and no more than 40% will consist of shares of St. Jude Medical common stock, as determined as set forth in the Merger Agreement.
Consummation of the Merger is subject to customary conditions, including (i) the approval and adoption by the requisite vote of the holders of the outstanding shares of common stock of the Company, (ii) authorization of the
listing of St. Jude Medical common stock for trading on the NYSE, (iii) absence of a Material Adverse Effect (as defined in the
12
Agreement) and (iv) certain regulatory approvals. Additionally, consummation of the Merger is subject to conditions requiring (1) that other
parties to certain contracts shall not have terminated or repudiated, or given notice of an intent to terminate or repudiate, any such contract and (2) that the US Food and Drug Administration (“FDA”) shall not have restricted the
Company’s ability to (i) manufacture, market, sell or otherwise distribute any Company products previously approved or cleared by the FDA for marketing and sale or (ii) obtain approval or clearance to market and sell any products
which have not yet been approved or cleared for marketing and sale by the FDA.
Overview
We were incorporated in January 1993 and operate in a single industry segment. We develop,
manufacture and market a line of products for use in the cardiac rhythm management or electrophysiology (“EP”) market which are used for visualization, diagnosis and treatment of cardiac rhythm disorders. The Company’s EP product line
includes the EP-WorkMate
®
computerized electrophysiology workstation, with options to incorporate our EP-4™ Computerized Cardiac Stimulator, our NurseMate™ Remote Review Charting
Station, and products linking our systems to hospital IT networks. We also sell products linking our EP WorkMate
®
system to products of market leaders, such as our MapMate
®
Navigation Interface with Biosense Websters’ CARTO mapping navigation system, Philips Medical Systems’ Allura x-ray system and with other technologies and systems.
The EP-WorkMate
®
system is a
computerized electrophysiology workstation that monitors, displays and stores cardiac electrical activity and arrhythmia data. It offers, among other features, display and storage of up to 192 intracardiac signals, real-time diagnosis, analysis and
integration with our own proprietary systems, such as our EP-4™ Stimulator, as well as with the systems of other market leaders and with other technologies and systems. In the fourth quarter of 2006, we received market clearance from the United
States Food and Drug Administration (“FDA”) to sell the MapMate
™
interface in the United States. The MapMate
®
integrates J & J’s Biosense Webster Division’s CARTO Mapping navigation system, allowing EP studies to be more efficient and user friendly. The EP-4™ Stimulator is a computerized signal generator and processor which, when
integrated with the EP-WorkMate
®
system, is used to stimulate the heart with electrical impulses in order to locate arrhythmia. The NurseMate™ Remote Review Charting Station is an
integrated monitoring and review station that allows a separate EP WorkMate
®
user to review and edit patient study data. We believe that the EP-WorkMate
®
system, when integrated with the EP-4™ Stimulator, offers the most advanced diagnostic computer system available to the electrophysiology market. The EP-WorkMate
®
platform accounted for approximately 89% of our total sales for each of the three month periods ended March 31, 2008 and 2007.
We have developed an intracardiac echo (ultrasound or ICE) ultrasound catheter system, comprised
of our ViewFlex
®
intracardiac imaging catheters and ViewMate
®
II ultrasound imaging console. These products offer
high-resolution, real-time ultrasound imaging capability designed to improve a physician’s or clinician’s ability to visualize anatomy and devices inside the chambers of the heart. We believe the ViewFlex
®
catheters and ViewMate
®
II Ultrasound systems will play an important role for a broad range of potential applications in electrophysiology and
interventional cardiology. Sales of the ViewFlex
®
catheters and related ViewMate
®
II systems accounted for approximately 7% and
6% of our total sales for the three month periods ended March 31, 2008 and 2007, respectively. In April, 2007, we launched for sale the new ViewMate
®
II ultrasound system based on
Philips Medical Systems’ HDII XE platform. Philips acts as an original equipment manufacturer for the product to be sold under our proprietary name ViewMate
®
II. As part of the joint
development and distribution agreement, we have exclusive rights to sell this platform in hospital electrophysiology (“EP”) and cardiac catheterization labs, and Philips may offer the ICE option to its customers in cardiac ultrasound and
other hospital departments on the HDII XE ultrasound system, providing additional platforms capable of using our ViewFlex
®
catheters.
Net sales in the three months ended March 31, 2008 increased by 29% to $4.6 million compared
to the first quarter of 2007 led by increased sales of our EP WorkMate
®
platform with new integrated NurseMate™ and MapMate
®
product features. Also, intracardiac ultrasound revenue grew by 54% to $306,000 compared to the first quarter of 2007.
The Company’s
net loss was $1.2 million, or $.04 per share, for the three months ended March 31, 2008 as compared to $1.5 million or $0.05 per share, for the three months ended March 31, 2007.
On February 28, 2008, we closed on a $3 million loan facility as more fully described below. The facility is made up of a $1.5 million asset based
revolving credit line and a $1.5 million term loan, each with a three year term and each is secured by of our assets. We used the proceeds from the loan to pay off our $2.0 million convertible debt which matured on February 28, 2008.
13
Results of Operations.
Revenues and Gross Margin on Product Revenues
Our revenues and gross margin on product revenues were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
For The Three Months
Ended March 31,
|
|
|
|
|
2008
|
|
|
2007
|
|
|
EP-WorkMate
®
platform
|
|
$
|
4,062,000
|
|
|
$
|
3,158,000
|
|
|
ViewFlex
TM
catheters and ViewMate
®
II ultrasound systems
|
|
|
306,000
|
|
|
|
199,000
|
|
|
ALERT
®
System, EP catheters and other
|
|
|
204,000
|
|
|
|
187,000
|
|
|
|
|
|
|
|
|
|
|
|
|
Total revenue
|
|
$
|
4,572,000
|
|
|
$
|
3,544,000
|
|
|
Cost of products sold
|
|
|
1,275,000
|
|
|
|
1,157,000
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit
|
|
$
|
3,297,000
|
|
|
|
2,387,000
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit as a percentage of total revenue
|
|
|
72
|
%
|
|
|
67
|
%
|
|
|
|
|
|
|
|
|
|
|
THREE MONTHS ENDED MARCH 31, 2008 AS COMPARED TO THE THREE MONTHS ENDED MARCH 31, 2007
Revenues and Gross Margin
The Company had net sales of $4,572,000 for the three months ended March 31, 2008, as compared to $3,544,000 for the comparable period in 2007. This $1,028,000 (or 29%) increase was primarily due to increased
sales of our EP-WorkMate
®
platform and new integrated NurseMate™ and MapMate™ product features. We also had higher sales of EP-4™ Stimulators and other EP-WorkMate
®
warranties, upgrades and peripheral products as compared to the same period in 2007. Sales of ultrasound products increased by 54% to $306,000 during the three months ended March 31, 2008
as compared to 2007 due to the introduction of the ViewMate
®
II ultrasound system in April, 2007. Total domestic sales increased by approximately 42% during the three months ended
March 31, 2008 as a result of increased sales activity of the EP-WorkMate
®
platform with integrated NurseMate™ and MapMate™ product features and increased sales of ultrasound
products.
Gross profit on sales for the three months ended March 31, 2008 was
$3,297,000, an increase of 38%, as compared with $2,387,000 for the same period in 2007. Gross profit as a percentage of sales was 72% as compared to 67% in the first quarter of 2007. The increase in gross margin can be attributed to several factors
including, a higher percentage of domestic sales, which have a higher gross margin than international sales and an increase in our average revenue per transaction for the EP WorkMate
®
platform through new product features which are integrated into our existing EP-WorkMate
®
platform.
Operating Expenses
The following is a summary of other operating expenses in dollars and as a percent of total revenue:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
|
|
March 31, 2008
|
|
|
March 31, 2007
|
|
|
|
|
($)
|
|
Percent of
revenue
|
|
|
($)
|
|
Percent of
revenue
|
|
|
Sales and marketing expenses
|
|
$
|
2,497,000
|
|
55
|
%
|
|
$
|
2,310,000
|
|
65
|
%
|
|
General and administrative expenses
|
|
|
971,000
|
|
21
|
%
|
|
|
946,000
|
|
27
|
%
|
|
Research and development expenses
|
|
|
1,063,000
|
|
23
|
%
|
|
|
666,000
|
|
19
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating expenses
|
|
$
|
4,531,000
|
|
99
|
%
|
|
$
|
3,922,000
|
|
111
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating expenses increased by $609,000, or 16%, to $4,531,000 for the three months ended
March 31, 2008 as compared to the same period in 2007.
Sales and marketing expenses increased by $187,000, or 8%, to $2,497,000 for
the three months ended March 31, 2008 as compared to the same period in 2007. The increase was due to increased compensation, travel and other costs for additional ultrasound sales and clinical support personnel. This increase was partially
offset by lower costs incurred as we are in the process of closing our European sales office. Additionally, in 2007, we recovered a previously written off accounts receivable of approximately $100,000 during the first quarter of 2007 resulting in a
reduction in our bad debt expense.
14
General and administrative expenses increased $25,000, or 3%, to $971,000 for the three months ended
March 31, 2008, as compared to the same period in 2007. The increase was partially due to legal costs. The increase was partially offset by lower costs incurred as we are in the process of closing our European administrative office.
Research and development expenses increased $397,000, or 60% to $1,063,000 for the three months ended March 31, 2008 as compared to the same
period in 2007. The increase in research and development expenses during the first quarter of 2008 was due to increased investment for future ICE products, including product development, sterilization and packaging validation.
Non-Operating Income and Expenses
The following is a summary of
non-operating income and expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
For The Three Months
Ended March 31,
|
|
|
|
|
2008
|
|
|
2007
|
|
|
Interest and other income
|
|
$
|
34,000
|
|
|
$
|
90,000
|
|
|
Interest expense
|
|
$
|
(42,000
|
)
|
|
$
|
(64,000
|
)
|
Interest and other income decreased by $56,000 or 62% to $34,000 for the three months ended
March 31, 2008 as compared to the same period in 2007. The Company completed a private placement in March, 2006 which led to higher interest income commencing in the second quarter of 2006. Interest income has declined as the Company’s
overall cash balance has declined.
Interest expense decreased $22,000 or 34% to $42,000 for the three months ended March 31, 2008, as
compared to the same period in 2007. The decrease in interest is primarily the result of a lower effective interest rate on the Company’s new $3 million Keltic Loan Agreement as compared to the prior Laurus secured convertible debt. Also, the
Company carried a lower daily average outstanding loan balance following its February 28, 2008 debt refinancing.
Liquidity and Capital Resources
Since our incorporation in January 1993, our expenses have exceeded sales, resulting in an accumulated deficit of $62 million at
March 31, 2008. Our cash and cash equivalents were approximately $5.1 million and $5.6 million as of March 31, 2008 and December 31, 2007, respectively. Based upon our current operating plans and projections, we believe that
our existing capital resources, comprised of cash on hand and the remaining borrowing availability under the Keltic loan, will be sufficient to meet our anticipated capital needs through the end of December 2008 although there can be no assurance of
this as this estimate is based upon a number of assumptions, which may not hold true.
The failure to complete of the merger with St. Jude
Medical may impact the Company’s future liquidity and capital requirements. In that event, the Company may seek to raise funds to meet our long term capital needs through equity or debt financings, collaborative or other arrangements with third
parties or through other sources of financing. There can be no assurance that such funds will be available on terms favorable to the Company, if at all. Also, there can be no assurance, assuming we successfully raise additional funds, that we will
achieve positive cash flow. If we are not able to secure additional funding, we may be required to scale back our sales and marketing efforts, research and development programs and general and administrative activities and possibly seek to sell or
license rights to our products to third parties.
Financing Activities
On February 28, 2008, the Company entered into a $3 million secured loan agreement (the “Keltic Loan Agreement”) with Keltic Financial Partners L.P. (“Keltic”), which included (i) a
$1,500,000 revolving loan (the “Revolving Loan”), and (ii) a $1,500,000 term loan (the “Term Loan”). The loans are secured by a first lien on all of our assets, including intellectual property. We used proceeds of the loan
to repay our $2 million secured convertible note which matured on February 28, 2008.
The Revolving Loan bears interest at the greater
of: (a) the prime rate plus 1.75% or (b) eight percent (8.00%). The Term Loan bears interest at the greater of: (a) the prime rate plus 2.00% or (b) eight and one-quarter percent (8.25%). The maturity date of the Revolving Loan
is February 28, 2011. The Term Loan requires principal payments of $25,000 per month for thirty-six (36) months followed by a balloon payment of $600,000 on February 28, 2011, unless the Keltic Loan Agreement is extended, in which
case we will continue to pay $25,000 per month through February 28, 2013. On and after the occurrence of an Event of Default (as defined in the Keltic Loan Agreement), all principal, interest and all other amounts due under the Term and
Revolving Loans may be accelerated at the sole option of Keltic and the interest rate on the loans may be increased three and one-half percent (3.5%) per annum.
15
We issued Keltic a warrant to purchase 25,000 shares of our Common Stock at $2.50 per share exercisable
for a five year period.
During the first quarter of 2007, we received $52,800 in proceeds from the exercise of employee stock options.
Operating Activities
Net cash used in
operating activities for the three months ended March 31, 2008 was $1,118,000 as compared to net cash provided by operations of $48,000 during the same period in 2007. Our net loss of $1,243,000 contributed to our net cash used in operations
during 2008. The increase in our cash used in operations in 2008 compared to 2007 was primarily due to the decrease of accounts receivable of $1,492,000 during the three months ended March 31, 2007 as the company collected several large past
due amounts. We had non-cash share based compensation costs of $203,000.
We evaluate the collectibility of our receivables quarterly. The
allowance for bad debts is based upon specific identification of customer accounts for which collection is doubtful and our estimate of the likelihood of potential loss. To date, we have experienced only modest credit losses with respect to our
accounts receivable. To date, we have experienced minor inventory write-downs, and the reserve is consistent with management’s expectations.
We have a history of operating losses and we expect to continue to incur operating losses in the near future as we continue to expend substantial funds for research and development, increased manufacturing activity and expansion of sales
efforts, especially as we attempt to increase our market share of our ultrasound product line. The amount and timing of future losses will depend upon, among other things, volume of sales of our existing products, market acceptance of the ultrasound
products, and developmental, regulatory and market success of new products under development, as well as our ability to establish, preserve and enforce intellectual property rights related to our products. There can be no assurance that any of our
development projects will be successful or that if development is successful, the products will generate any sales. Based upon our current plans and projections, we believe that our existing capital resources will be sufficient to meet our
anticipated capital needs through the end of the fourth quarter of 2008.
Investing Activities
Capital expenditures totaled $44,000 and $61,000 for the three months ended March 31, 2008 and 2007, respectively. We do not expect capital
expenditures to increase materially in 2008.
Off-Balance Sheet Arrangements
As of March 31, 2008, we did not have any off-balance sheet arrangements as defined in Item 303(a)(4)(ii) of Regulation S-K.
Summary of Contractual Obligations
The following
table summarizes our contractual cash obligations at March 31, 2008, and the effects such obligations are expected to have on liquidity and cash flow in future periods. We do not have any other commercial commitments.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Payments Due by Period
|
|
Contractual Obligations
|
|
Total
|
|
Less than
1 year
|
|
1-3 years
|
|
4-5
years
|
|
After
5 years
|
|
Long-Term Debt (1) (2)
|
|
$
|
1,500,000
|
|
$
|
300,000
|
|
$
|
1,200,000
|
|
$
|
0
|
|
$
|
0
|
|
Revolving Credit Agreement (1) (2)
|
|
$
|
1,200,000
|
|
$
|
1,200,000
|
|
$
|
0
|
|
$
|
0
|
|
$
|
0
|
|
Operating Lease Obligations
|
|
$
|
130,000
|
|
$
|
101,000
|
|
$
|
29,000
|
|
$
|
0
|
|
$
|
0
|
|
Other Long Term Obligations (3)
|
|
$
|
0
|
|
$
|
0
|
|
$
|
0
|
|
$
|
0
|
|
$
|
0
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Contractual Cash Obligations (3)
|
|
$
|
2,830,000
|
|
$
|
1,601,000
|
|
$
|
1,229,000
|
|
$
|
0
|
|
$
|
0
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1)
|
We are contractually obligated to pay variable interest on the Long-Term Debt and Revolving Credit Agreement
|
|
(2)
|
On February 28, 2008, we entered into a $3 million secured loan agreement with Keltic which included (i) a $1,500,000 revolving loan (the “Revolving Loan”), and
(ii) a $1,500,000 term loan (the “Term Loan”). The loans are secured by a first lien on all of our assets, including intellectual property. We used proceeds of the loan to repay its $2 million secured convertible note which matured on
February 28, 2008.
|
The Revolving Loan bears interest at the greater of: (a) the prime rate plus 1.75% or
(b) eight percent (8.00%). The Term Loan bears interest at the greater of: (a) the prime rate plus 2.00% or (b) eight and one-quarter percent (8.25%). The maturity date of the Revolving Loan is February 28, 2011. The Term Loan
requires principal payments of $25,000
16
per month for thirty-six (36) months followed by a balloon payment of $600,000 on February 28, 2011, unless the Keltic Loan Agreement is extended,
in which case we will continue to pay $25,000 per month through February 28, 2013. On and after the occurrence of an Event of Default (as defined in the Keltic Loan Agreement), all principal, interest and all other amounts due under the Term
and Revolving Loans may be accelerated at the sole option of Keltic and the interest rate on the loans may be increased three and one-half percent (3.5%) per annum.
|
(3)
|
We also have contractual obligations for certain licensing contracts. We have signed a license agreement with Biosense
Webster that provides for a license payment on sales of MapMate
®
units. This license is payable upon sales of the units. We also have other license agreements which we may terminate
unilaterally in the event that the technology is no longer deemed relevant.
|
Cautionary Statement Regarding Forward-Looking Statements
In addition to historical information, this Quarterly Report on Form 10-Q contains forward-looking statements relating to such matters
as anticipated financial and operational performance, business prospects, technological developments, results of clinical trials, new products, research and development activities and similar matters. The Private Securities Litigation Reform Act of
1995 provides a safe harbor for forward-looking statements. We emphasize to you that a variety of factors could cause our actual results and experience to differ materially from the anticipated results or other expectations expressed in our
forward-looking statements. When we use the words or phrases “believe,” “anticipate,” “expect,” “intend,” “will likely result,” “estimate,” “project” or similar expressions in
this Quarterly Report on Form 10-Q, we intend to identify such forward-looking statements, but they are not the exclusive means by which such statements are made. The forward-looking statements are only expectations and/or predictions which are
subject to risks and uncertainties, including the significant factors discussed under “Risk Factors” in our most recent Form 10-K, and general economic, market or business conditions, opportunities or lack of opportunities that may be
presented to us, competitive actions, changes in laws and regulations and other matters discussed herein in the section entitled “Item 2—Management’s Discussion and Analysis of Financial Condition and Results of Operations” and
in other sections herein.
We caution readers to review the cautionary statements set forth in this Quarterly Report on Form 10-Q and in
our other reports filed with the Securities and Exchange Commission and caution that other factors may prove to be important in affecting our business and results of operations. We caution you not to place undue reliance on these forward-looking
statements, which speak only as of the date of this Quarterly Report. We undertake no obligation to publicly revise these forward-looking statements to reflect events or circumstances that arise after the date of this report.
Critical Accounting Policies
Financial Reporting
Release No. 60 requires all companies to include a discussion of critical accounting policies or methods used in the preparation of financial statements. The Commission indicated that a critical accounting policy is one which is important to
the portrayal of the company’s financial condition and results and requires management’s most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently
uncertain. Note 2 of the Notes to the Consolidated Financial Statements filed on the Company’s Form 10-K for the year ended December 31, 2007 includes a summary of the significant accounting policies and methods used in the preparation of
our Consolidated Financial Statements. The critical accounting estimates included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2007 have not materially changed.
In addition, Financial Reporting Release No. 61 requires all companies to include a discussion to address, among other things, liquidity,
off-balance sheet arrangements, contractual obligations and commercial commitments. The information provided below describing our debt and future commitments is provided to facilitate a review of our liquidity and capital resources. The following is
a brief discussion of the more significant accounting policies and methods used by us.
General
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make
estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Judgments and assessments of uncertainties are required in applying the Company’s accounting policies in the valuation of accounts
receivable, valuation of inventory, valuation of goodwill intangibles, and other long-term assets, income taxes and share-based compensation. The Company bases its judgments and estimates on historical experience and other assumptions that it
believes are reasonable. Although these estimates are based upon management’s knowledge of current events, the estimates may ultimately differ from actual results.
17
Revenue Recognition
We ship products to our customers based on FOB shipping point and, as such, recognize product sales on the date of shipment. Installation of the products is considered perfunctory. Payments received in advance of
shipment of product are deferred until such products are shipped. We do not have royalty agreements that result in revenue to us and we do not provide distributors or end-users with a general right to return products purchased.
We have three sales channels: Direct sales to customers, sales to independent distributors, and
sales to alliance partners. Our products do not require “installation” in the traditional sense, but the EP-WorkMate
®
system does require a set up. For distributors, the
distributor is responsible for set-up of all electronic hardware products, and we have no obligation after shipment of products to the distributors. For direct sales, while the customer can perform the set-up on its own, our personnel generally will
assist customers in this process. The set-up process, which takes approximately 1-2 hours to complete, is usually performed shortly after shipment and primarily consists of assembling the workstation cart and plugging in the monitors, printer,
isolation transformer, and the EP-4™ Stimulator to the main computer. This process does not impact our standard payment terms. For sales to distributors, payment terms are defined in the distributor agreements as 100% of the purchase price
being due 30 to 60 days after shipment. For direct sales, payment terms are agreed in advance of the sale with the balance due 30 to 60 days after shipment.
We provide a one-year warranty on all of our electronic products, and in accordance with Statement of Financial Accounting Standard No. 5 “Accounting for Contingencies”, accrue for the estimated cost of
providing the warranty at the time of sale. Further, the Company incurs discretionary costs to service its products in connection with product performance issues. The estimates of the future warranty costs are based on historical experience.
|
|
|
|
|
|
|
|
|
|
|
|
|
For The Three Months Ended
March 31,
|
|
|
|
|
2008
|
|
|
2007
|
|
|
Beginning balance
|
|
$
|
244,000
|
|
|
$
|
$272,000
|
|
|
Warranties
|
|
|
(10,000
|
)
|
|
|
79,000
|
|
|
Warranty payments
|
|
|
(36,000
|
)
|
|
|
(84,000
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Ending balance
|
|
$
|
198,000
|
|
|
$
|
267,000
|
|
|
|
|
|
|
|
|
|
|
|
We also sell various types of warranty contracts to our customers. These contracts range in term
from one to five years. Revenue is recognized on these contracts on a straight-line basis over the life of the contract.
Valuation of Accounts
Receivable
We continuously monitor customers’ balances, collections and payments, and maintain a provision for estimated credit
losses based upon our historical experience, changes in the financial condition of our customers, and any specific customer collection issues that we have identified. In addition, due to the significant average selling price of our equipment, any
single write-off of a customer balance could be substantial. We may request letters of credit from our customers when we believe that there is a significant risk of credit loss. Our allowance for doubtful accounts was $109,000 and $107,000 at
March 31, 2008 and December 31, 2007, respectively. During the three month period ended March 31, 2007, we recovered a previously written off accounts receivable of approximately $100,000 and recorded a reduction in our bad debt
expense. While such credit losses have historically been within our expectations and the provisions established, we cannot guarantee that we will continue to experience the same credit loss rates that we have in the past.
Valuation of Inventory
We value our inventory at the
lower of cost or market, with cost being determined on a first-in, first-out basis. We continually monitor our slow-moving items, and establish reserve amounts on a specific identification basis, as necessary. In addition, due to the fact that our
business is dependent on the latest computer technology, we continually monitor our inventory and products for obsolescence. If we determine market value to be less than cost, we write down the cost to that value. Additional reserves are sometimes
established as a result of lack of marketability or changes in customer consumption patterns. Management’s judgment is necessary in determining the realizable value of those products to arrive at the proper obsolescence reserve. These reserves
are estimates, which could change significantly, either favorably or unfavorably, depending on market and competitive conditions.
18
Valuation of Goodwill, Intangible Assets, and Other Long-Lived Assets
At March 31, 2008, the Company had net goodwill of $342,000 which represents the excess of the cost over the fair value of net assets acquired in
business combinations. Currently, the Company operates as a single reporting unit. Goodwill and other “indefinite-lived” assets are not amortized and are subject to the impairment rules of Statement of Financial Accounting Standards
No. 142. Goodwill is tested for impairment annually or more frequently if changes in circumstance or the occurrence of events suggest impairment exists. There was no impairment loss recorded during the three month period ending March 31,
2008.
The Company determines the fair market value of its reporting unit using quoted market rates and cash flow techniques. The fair
market value of the reporting unit is compared to the carrying value of the reporting unit to determine if an impairment loss should be calculated. If the book value of the reporting unit exceeds the fair value of the reporting unit, an impairment
loss is indicated. The loss is calculated by comparing the fair value of the goodwill to the book value of the goodwill. If the book value of the goodwill exceeds the fair value of goodwill, an impairment loss is recorded. Fair value of goodwill is
determined by subtracting the fair value of the identifiable assets of a reporting unit from the fair value of the reporting unit. There were no impairment losses recorded during the three month periods ending March 31, 2008 or 2007.
Income Taxes
We account for our
income taxes under the liability method. Under the liability method, deferred tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities as measured by the enacted tax
rates which will be in effect when these differences reverse. Deferred tax expense is the result of changes in deferred tax assets and liabilities. We have fully reserved our deferred tax asset given our past history of operating losses.
|
Item 3.
|
Quantitative and Qualitative Disclosures About Market Risk
|
We are exposed to a variety of risks, including changes in interest rates affecting our outstanding debt balance and fixed rate investments of our cash and cash equivalents and foreign currency fluctuations. The Company does not have any
market risk with respect to such factors as commodity prices or equity prices. We do not invest in, or otherwise use, foreign currency or other derivative financial or derivative commodity instruments, and we do not engage in hedging transactions
for speculative or trading or any other purposes.
Interest Rate Risk
Our exposure to market risk for changes in interest rates relates primarily to our investment portfolio for our debt obligations and our cash and cash
equivalents.
At March 31, 2008, we had a Term Loan outstanding in the amount of $1,500,000 and a Revolving Credit Loan outstanding in
the amount of $1,200,000. Interest on the Term and Revolving Loans are based on the prime rate. This floating rate debt may lead to additional interest expense if interest rates increase. Because management does not believe that our exposure to
interest rate market risk is material at this time, we have not developed or implemented a strategy to manage this market risk through the use of derivative financial instruments or otherwise. We will assess the significance of interest rate market
risk from time to time and will develop and implement strategies to manage that market risk as appropriate.
We invest our excess cash in
money market funds and government securities, which creates a degree of interest rate risk. Our primary exposure to market risk relates to changes in interest rates on our cash and cash equivalents. Our primary investment objective with respect to
our cash and cash equivalents is to preserve principal, while at the same time maximizing yields without significantly increasing risk.
Our portfolio includes money markets funds and/or government securities. The diversity of our portfolio helps us to achieve our investment objective. As of March 31, 2008, 100% of our investment portfolio matures less than 90 days from
the date of purchase. Due to the short-term nature of these investments, we believe that we are not subject to any material market risk exposure, and as a result, the estimated fair value of our cash and cash equivalents approximates their principal
amounts. If market interest rates were to increase immediately and uniformly by 10% from levels at March 31, 2008, we estimate that the fair value of our investment portfolio would decline by an immaterial amount.
Foreign Currency Risk
Our
international revenues were 23% and 30% of our total revenues in the three months ended March 31, 2008 and 2007, respectively. Our international sales are made through international distributors, our direct sales force and sales to alliance
partners, with payments to the Company typically denominated in United States dollars and the Euro. For the three months ended March 31, 2008, approximately 18% of our foreign sales (or 4% of our total sales) were denominated in the
19
Euro. Management has determined that the impact of foreign currency risk is minimal since a majority of our sales are billed in United States dollars. Our
international business is subject to risks typical of an international business, including, but not limited to, differing economic conditions, changes in political climate, differing tax structures, other regulations and restrictions, and foreign
exchange rate volatility. Accordingly, our future results could be materially adversely affected by changes in these or other factors. We do no hedge our foreign currency exposure at present.
|
Item 4.
|
Controls and Procedures
|
As of the end of the
period covered by this report, the Company conducted an evaluation, under the supervision and with the participation of our principal executive officer and principal financial officer, of the effectiveness of the Company’s disclosure controls
and procedures (as defined in Rule 13a-15 and 15d-15 of the Exchange Act). Based on this evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures are effective to ensure that
information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission rules and
forms. It should be noted that the design of any system of controls is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all
potential future conditions, regardless of how remote.
There was no change in the Company’s internal control over financial reporting
during the Company’s most recently completed fiscal quarter that has materially affected, or is reasonably likely to materially effect, the Company’s internal controls over financial reporting.
PART II. OTHER INFORMATION
|
Item 1.
|
Legal Proceedings.
|
During the second quarter of
2005, the Company announced it was under investigation with the United States Department of Commerce, the United States Attorney’s Office for the District of New Jersey and the United States Department of the Treasury in connection with the
sale of certain of its products to Iran. In addition, the Company announced the SEC was conducting a confidential, informal inquiry into the Company’s financial and accounting reporting regarding there investigations.
In November 2006, the Company signed an agreement to settle this matter with the Department of Commerce prior to the issuance of a formal charging
letter. Under the settlement agreement, the Company paid $244,000 in civil penalties and was not subject to any restrictions on commercial or export activities.
In February, 2007, the Company reached a settlement agreement with the Department of the Treasury for a payment of $33,000 without admitting or denying guilt, which had been accrued in 2006. Additionally, the Company
agreed to conduct certain compliance and internal audit procedures for three years.
The Company cannot assure that the ongoing informal
inquiry by the SEC will not result in other significant costs, fines or penalties that could, in the aggregate, have a material adverse effect on our business, financial condition, prospects or results of operations. The Company has made no
provision for any future costs associated with these investigations or any costs associated with the Company’s defense or negotiations with the SEC entities to resolve this final outstanding issue.
Our business faces many
risks. Any of the risks discussed in this Form 10-Q or our other SEC filings, could have a material impact on our business, financial position or results of operations. Additional risks and uncertainties not presently known to us or that
we currently believe to be immaterial may also impair our business operations.
For a detailed discussion of the risk factors that should
be understood by any investor contemplating investment in our stock, please refer to the section entitled Part I, Item 1A, Risk Factors in our 2007 Form 10-K. There has been no material change in the risk factors set forth in our 2007 Form
10-K.
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Item 2.
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Unregistered Sales of Equity Securities and Use of Proceeds.
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(a) Not applicable
(b) Not applicable.
(c) Not applicable.
20
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Item 3.
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Defaults Upon Senior Securities.
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None.
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Item 4.
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Submission of Matters to a Vote of Security Holders.
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None.
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Item 5.
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Other Information.
|
(b) None.
The exhibits are listed in the Exhibit
Index appearing at page 22 herein.
21
SIGNATURES
In accordance with the requirements of the Exchange Act, the Registrant caused this report to be
signed on its behalf by the undersigned, thereunto duly authorized.
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|
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|
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|
|
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EP MEDSYSTEMS, INC.
(Registrant)
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|
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Date: May 13, 2008
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By:
|
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/s/ David I. Bruce
|
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David I. Bruce
|
|
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President and Chief Executive Officer
(Principal
Executive Officer)
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Date: May 13, 2008
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By:
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/s/ James J. Caruso
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James J. Caruso
|
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Chief Financial Officer
(Principal Financial and
Accounting Officer)
|
22
Index to Exhibits
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Exhibit
Number
|
|
Description
|
|
31.1*
|
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Certification of Principal Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002/SEC Rule 13a-14(a)
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|
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31.2*
|
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Certification of Principal Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002/SEC Rule 13a-14(a)
|
|
|
|
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32.1*
|
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Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
|
|
|
|
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32.2*
|
|
Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
|
23
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