ITEM 1. FINANCIAL STATEMENTS
POSSIS MEDICAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements have been
prepared in accordance with accounting principles generally accepted in the
United States of America for interim financial information and with the
instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly,
they do not include all of the information and footnotes required by
accounting principles generally accepted in the United States of America
for complete financial statements. In the opinion of management, all
adjustments (consisting of normal recurring accruals) considered necessary
for a fair presentation have been included. The accompanying consolidated
financial statements and notes should be read in conjunction with the
audited financial statements and accompanying notes thereto included in our
Annual Report on Form 10-K for the year ended July 31, 2007.
INTERIM FINANCIAL STATEMENTS
Operating results for the three and six months ended January 31, 2008 are
not necessarily indicative of the results that may be expected for the year
ending July 31, 2008.
INVESTMENT AND NOTE RECEIVABLE IN RAFAEL MEDICAL
We hold an investment in Rafael Medical Technologies, Inc. (Rafael), a
company developing an inferior vena cava (IVC) filter named SafeFlo(R). In
December 2006, we invested $2.5 million in a series of preferred stock of
Rafael that represents a 15 percent ownership interest and also executed a
stock purchase agreement that provides us a right for a period of
three-years to purchase the remaining capital stock of Rafael that is or
may become outstanding. In December 2007, the Company provided an
additional $1.5 million to Rafael in secured debt financing as agreed upon
in the stock purchase agreement. Interest income on the $1.5 million note
receivable will be recognized when received. The preferred stock purchase
agreement provides us with a number of rights as an investor. The total
investment on the balance sheet of $2,612,000 reflects $112,000 of
transaction-related costs that were capitalized. As of January 31, 2008,
management determined that there was no impairment in the value of its
investment in Rafael which is accounted for under the cost method.
2. NET INCOME (LOSS) PER COMMON SHARE
Basic income (loss) per common share is computed by dividing net income for
the period by the weighted average number of common shares outstanding
during the period. Diluted income per share is computed using the treasury
stock method by dividing net income by the weighted average number of
common shares plus the dilutive effect of outstanding stock options, and
shares issuable under the employee stock purchase plan (ESPP).
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The following table presents a reconciliation of the numerators and
denominators of basic and diluted earnings per share:
Three Months Ended Six Months Ended
January 31, January 31,
----------------------- ------------------------
2008 2007 2008 2007
----------- ----------- ------------ -----------
Numerator:
Net income (loss) $ 569,561 $ 173,700 $ 673,776 $ (59,949)
=========== =========== =========== ============
Denominator:
Weighted average common shares outstanding
16,955,183 17,179,940 16,931,284 17,164,966
Effect of potentially dilutive securities:
Stock options and other 778,566 554,305 693,475 -
----------- ----------- ----------- ------------
Weighted average common shares
outstanding, assuming dilution 17,733,749 17,734,245 17,624,759 17,164,966
=========== =========== =========== ============
Basic earnings per share $ 0.03 $ 0.01 $ 0.04 $ 0.00
Diluted earnings per share $ 0.03 $ 0.01 $ 0.04 $ 0.00
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Potential dilutive securities include stock options, non-vested share
awards, and shares issuable under our ESPP.
The computation of dilutive shares outstanding excluded options to purchase
760,000 and 1,418,000 shares of common stock for the three months ended
January 31, 2008 and 2007, and 879,000 and 1,423,000 shares of common stock
for the six months ended January 31, 2008 and 2007, respectively. These
amounts were excluded because the option exercise prices were greater than
the weighted average closing market price of our common stock for the
periods presented and therefore, the effect would be antidilutive (i.e.,
including such options would result in higher earnings per share.) In
addition, the computation of dilutive shares outstanding excluded options
to purchase an additional 583,000 shares of common stock for the six months
ended January 31, 2007 due to the Company having a net loss.
3. STOCK-BASED COMPENSATION
We have a stock-based compensation plan under which we grant stock options
and restricted stock (non-vested share awards) and also have an Employee
Stock Purchase Plan (ESPP). All stock options issued prior to July 31, 2005
have a ten-year term. All stock options issued subsequent to July 31, 2005
have a five-year term. Although outstanding stock options issued to
employees generally vest over a four-year period, on occasion we have
issued options that vest based upon achieving corporate objectives or stock
price performance. Outstanding stock options issued to directors vest over
the following periods, depending on the basis for issuance: a) six months -
stock options in lieu of compensation for services rendered as directors,
b) four years - annual grants of stock options and c) stock price
performance with a five-year cliff period - service award options.
Directors also receive an annual non-vested share award that vests upon
continued service (time-based) of one year. Our ESPP permits employees to
purchase stock at 85 percent of the market price of our common stock at the
end of each quarterly purchase period.
Total stock-based compensation expense included in our statement of income
for the three months ended January 31, 2008 and 2007, was $536,000, net of
tax and $662,000, net of tax, respectively. Total stock-based compensation
expense included in our statement of income for the six months ended
January 31, 2008 and 2007, was $1,810,000 and $2,446,000, net of tax,
respectively.
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The following table summarizes the stock option transactions for the six
months ended January 31, 2008:
Weighted-
Weighted- Average Average Remaining
Exercise Price Contractual Term
Options Per Share (in years)
Outstanding on July 31, 2007 3,324,000 $ 11.12
Granted 389,000 $ 10.27
Exercised (61,000) $ 14.05
Forfeited/Canceled (115,000) $ 13.84
==================== ==================
Outstanding on January 31, 2008 3,537,000 $ 11.03 4.03
==================== ================== ===================
Exercisable on January 31, 2008 2,448,000 $ 11.03 1.95
==================== ================== ===================
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Note: At January 31, 2008, shares associated with our ESPP were not
significant and were excluded from the table above.
The aggregate intrinsic value of options (the amount by which the market
price of the stock on date of exercise exceeded the market price of the
stock on the date of grant) exercised during the three months ended January
31, 2008 and 2007, was $256,000 and $101,000, respectively; and during the
six months ended January 31, 2008 and 2007, was $358,000 and$101,000,
respectively.
We estimated the fair values using the Actuarial Binomial option-pricing
model, modified for dividends and using the following assumptions:
Six Months Ended
January 31,
------------------------------------------------
2008 2007(1)
-------------------- ---------------------
Risk-free rate(2)............................. 3.1-4.7% 4.7-4.9%
Expected dividend yield...................... 0% 0%
Expected stock price volatility(3)............ 55% 55-56%
Expected life of stock options(4)............. 4.16 years 4.15 years
Fair value per option........................ $4.82-$7.97 $4.17-$8.31
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1. Forfeitures are estimated based on historical experience.
2. Based on the U.S. Treasury interest rates whose term is consistent with
the expected life of our stock options.
3. We used an outside valuation advisor to assist us in projecting expected
stock price volatility. Historical market price data was used.
4. We estimate the expected life of stock options based upon historical
experience.
Net cash proceeds from the exercise of stock options were $523,000 and
$62,000 for the six months ended January 31, 2008 and 2007, respectively.
The actual income tax benefit realized from stock option exercises was
$138,000 and $13,000 for the six months ended January 31, 2008 and 2007,
respectively.
Non-Vested Share Awards
The fair value of non-vested market-based and time-based share awards is
determined based on generally accepted valuation techniques and the closing
market price of our stock on the date of grant. A summary of the status of
our non-vested market-based and time-based share awards as of January 31,
2008 and changes during the six-month period ended January 31, 2008, is as
follows:
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Market-Based and Time-Based Share Awards Shares Fair Value
---------------------------------------- ------ ----------
Outstanding at July 31, 2007 3,174 $ 13.47
Granted 70,638 10.37
Vested (14,511) 11.07
Forfeited/Canceled (5,544) 10.19
-------------- --------------
Outstanding at January 31, 2008 53,757 $ 13.98
============== ==============
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As of January 31, 2008, there was $468,000 of unrecognized compensation
expense related to non-vested time-based share awards that is expected to
be recognized over the life of the awards.
4. ACCOUNTING PRONOUNCEMENTS
SFAS No. 157
In March 2006, the FASB issued FASB No. 157, "Fair Value
Measurements." This Statement defines fair value, establishes a
framework for measuring fair value in generally accepted accounting
principles (GAAP), and expands disclosures about fair value
measurements. This Statement applies under other accounting
pronouncements that require or permit fair value measurements, the
FASB having previously concluded in those accounting pronouncements
that fair value is the relevant measurement attribute. Accordingly,
this Statement does not require any new fair value measurements.
However, for some entities, the application of this Statement will
change current practice. This Statement is effective for financial
statements issued for fiscal years beginning after November 15,
2007, and interim periods within those fiscal years. Earlier
application is encouraged, provided that the reporting entity has
not yet issued financial statements for that fiscal year, including
financial statements for an interim period within that fiscal year.
Adoption is not expected to have a material impact on our
consolidated earnings, financial position or cash flows.
FIN No. 48
The Company adopted the provisions of FASB Interpretation No. 48,
Accounting for Uncertainty in Income Taxes, on August 1, 2007. See
Footnote 9 of the financial statements for an additional
description.
SFAS No. 158
The Company adopted the provisions FASB No. 158, "Employers'
Accounting for Defined Benefit Pension and Other Postretirement
Plans". This Statement improves financial reporting by requiring an
employer to recognize the overfunded or underfunded status of a
defined benefit postretirement plan (other than a multiemployer
plan) as an asset or liability in its statement of financial
position and to recognize changes in that funded status in the year
in which the changes occur through comprehensive income of a
business entity or changes in unrestricted net assets of a
not-for-profit organization. This Statement also improves financial
reporting by requiring an employer to measure the funded status of
a plan as of the date of its year-end statement of financial
position, with limited exceptions. This Statement is effective for
financial statements issued for fiscal years beginning after
December 15, 2006, and interim periods within those fiscal years.
Adoption did not have a material impact on our consolidated
earnings, financial position or cash flows.
SFAS No. 159
In February 2007, the FASB issued FASB No. 159, "The Fair Value
Option for Financial Assets and Liabilities". This Statement
permits entities to choose to measure many financial instruments
and certain other items at fair value. The objective is to improve
financial reporting by providing entities with the opportunity to
mitigate volatility in reported earnings caused by measuring
related assets and liabilities differently without having to apply
complex hedge accounting provisions. This Statement is expected to
expand the use of fair value measurement, which is consistent with
the Board's long-term measurement objectives for accounting for
financial instruments. This Statement is effective for financial
statements issued for fiscal years beginning after November 15,
2007, and interim periods within those fiscal years. Earlier
application is encouraged, provided that the reporting entity has
not yet issued financial statements for that fiscal year, including
financial statements for an interim period within that fiscal year.
Adoption is not expected to have a material impact on our
consolidated earnings, financial position or cash flows.
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SFAS No. 160
In December 2007, the FASB issued FASB No. 160, "Noncontrolling
Interest in Consolidated Financial Statements" an amendment of ARB
No. 51. This Statement objective is to improve the relevance,
comparability, and transparency of the financial information that a
reporting entity provides in its consolidated financial statements
by establishing accounting and reporting standards that require:
o The ownership interests in subsidiaries held by parties
other than the parent be clearly identified, labeled, and
presented in the consolidated statement of financial
position within equity, separate from the parent's equity.
o The amount of consolidated net income attributable to the
parent and to the noncontrolling interest be clearly
identified and presented on the face of the consolidated
statement of income.
o Changes in a parent's ownership interest while the parent
retains its controlling financial interest in its subsidiary
be accounted for consistently. A parent's ownership interest
in a subsidiary changes if the parent purchases additional
ownership interests in its subsidiary. It also changes if
the subsidiary reacquires some of its ownership interests or
the subsidiary issues additional ownership interests. All of
those transactions are economically similar, and this
Statement requires that they be accounted for similarly, as
equity transactions.
o When a subsidiary is deconsolidated, any retained
noncontrolling equity investment in the former subsidiary is
measured at fair value. The gain or loss on the
deconsolidation of the subsidiary is measured using the fair
value of any noncontrolling equity investment rather than
the carrying amount of that retained investment.
o Entities provide sufficient disclosures that clearly
identify and distinguish between the interests of the
parents and the interests of the noncontrolling owners.
This Statement is effective for financial statements issued for
fiscal years beginning after December 15, 2008, and interim periods
within those fiscal years. Earlier adoption is prohibited. Adoption
is not expected to have a material impact on our consolidated
earnings, financial position or cash flows.
5. MARKETABLE SECURITIES
During the quarters ended January 31, 2008 and 2007, we primarily invested
excess cash and cash equivalents in a professionally managed portfolio of
marketable securities. All securities in this portfolio are classified as
available-for-sale and consist of U.S. government securities, municipal
bonds, mortgaged-back securities, asset-backed securities and corporate
bonds. These investments are reported at fair value. The unrealized gain,
net of taxes, on these investments of approximately $156,000 for the three
months ended January 31, 2008 and of approximately $219,000 and $188,000
for the six months ended January 31, 2008 and 2007 is included within other
comprehensive gain. The unrealized loss, net of taxes, on these
investments, of approximately $5,000 for the three months ended January 31,
2007 is included within other comprehensive loss. The net unrealized gain
included in shareholders' equity as of January 31, 2008 was $159,000, net
of tax. The net unrealized loss included in shareholders' equity as of
January 31, 2007 was $141,000, net of tax.
Of the $35,505,000 marketable securities portfolio at January 31, 2008,
$8,019,000 is invested in mortgage-backed securities, $3,376,000 is
invested in asset-backed securities and $3,400,000 is invested in auction
rate securities. These securities are rated AAA. We have not recorded an
impairment charge or similar write-down of the reported values as the
investments are reported at quoted market values. However, if these
securities were to begin trading below these values in the future or they
become illiquid, we may be required to record losses on these investments,
which would in turn negatively impact our results of operations and our
financial condition.
In February 2008, one of our auction rate securities ($250,000 at cost)
failed auction due to sell orders exceeding buy orders. The funds
associated with failed auctions will not be accessible until a successful
auction occurs or a buyer is found outside the auction process. These
securities are rated AAA. The values of the securities have not been
written down as the Company believes that any impairment in the fair market
value of these securities is only temporary. These securities will continue
to be analyzed each reporting period for other-than-temporary impairment
factors.
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6. INVENTORIES
Inventories are stated at the lower of cost (on the first-in, first-out
basis) or market. Inventory balances were as follows:
January 31, 2008 July 31, 2007
--------------------- ------------------------
Finished goods......................... $ 5,845,484 $ 4,206,290
Work-in-process........................ 1,827,424 2,544,172
Raw materials.......................... 3,303,273 2,601,426
--------------------- ------------------------
$ 10,976,181 $ 9,351,888
===================== ========================
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AngioJet System Ultra Consoles/drive units of $5,154,000 and $3,095,000
respectively are included in Finished Goods as of January 31, 2008 and July
31, 2007. The increase as of January 31, 2008, is due to the introduction
of the new Ultra Console in January 2007 which replaces the first
generation drive unit. The AngioJet System Ultra Consoles are primarily
evaluation units at customer locations.
7. PROPERTY AND EQUIPMENT
Property is carried at cost and depreciated using the straight-line method
over the estimated useful lives of the various assets. Property and
equipment balances and corresponding lives were as follows:
January 31, 2008 July 31, 2007 Life
--------------------- ------------------ -------------------
Leasehold improvements..................... $ 3,016,769 $ 2,928,531 5-10 years
Equipment.................................. 12,658,947 12,437,219 3-10 years
Assets in construction..................... 739,080 468,623 N/A
--------------------- ------------------
16,414,796 15,834,373
Less accumulated depreciation............... (11,904,304) (10,961,799)
--------------------- ------------------
Property and equipment - net............... $ 4,510,492 $ 4,872,574
===================== ==================
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8. PREPAYMENT TO VENDOR
In October 2007 we made a payment of $2,653,000 to an inventory vendor to
purchase inventory that will be utilized when the inventory is shipped to
us. At January 31, 2008, the estimated amount of the inventory prepayment
to be utilized beyond twelve months is $1,330,000.
9. INCOME TAXES
The Company adopted the provisions of FASB Interpretation 48, Accounting
for Uncertainty in Income Taxes (FIN No. 48), on August 1, 2007.
Previously, the Company had accounted for tax contingencies in accordance
with Statement of Financial Accounting Standards 5, Accounting for
Contingencies. As required by FIN 48, which clarifies Statement 109,
Accounting for Income Taxes, the Company recognizes the financial statement
benefit of a tax position only after determining that the relevant tax
authority would more likely than not sustain the position. For tax
positions meeting the more likely than not threshold, the amount recognized
in the financial statements is the largest benefit that has a greater than
50 percent likelihood of being realized upon ultimate settlement with the
relevant tax authority. At the adoption date, the Company applied FIN 48 to
all tax positions for which the statute of limitations remained open.
The Company computed the net impact of the adoption of FIN 48 to increase
retained earnings by $270,000. The total gross amount of unrecognized tax
benefits as of August 1, 2007 and January 31, 2008 was approximately
$1,955,000. If recognized, approximately $427,000 of the unrecognized tax
benefits would affect the effective tax rate.
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It is the Company's practice to recognize penalties and/or interest related
to income tax matters in income tax expense. As of August 1, 2007, the
Company had $16,000 of accrued interest and penalties included in the
$1,955,000 of unrecognized tax benefit.
The Company is subject to income taxes in the U.S. federal jurisdiction,
foreign jurisdictions and various state jurisdictions. Tax regulations
within each jurisdiction are subject to the interpretation of the related
tax laws and regulations and require significant judgment to apply. With
few exceptions, the Company is no longer subject to U.S. federal, foreign,
state or local income tax examinations by tax authorities for the years
before 2003. The Company is not currently under examination by any taxing
authority.
During the first two quarters of 2008, our total liability for unrecognized
tax benefits did not materially change. The Company does not anticipate
that total unrecognized tax benefits will significantly change within the
next 12 months.
10. SEGMENT AND GEOGRAPHIC INFORMATION
Our operations are in one business segment: the design, manufacture and
distribution of endovascular medical devices. We evaluate revenue
performance based on the worldwide revenues of each major product line and
profitability based on an enterprise-wide basis due to shared
infrastructures to make operating and strategic decisions.
Total revenues from sales in the United States and outside the United
States are as follows:
Three Months Ended Six Months Ended
January 31, January 31,
---------------------------------------- --------------------------------------
2008 2007 2008 2007
------------------- ------------------ ----------------- -----------------
United States................... $ 19,916,004 $ 15,301,243 $ 38,253,326 $ 30,482,289
Non-United States.............. 716,566 504,842 1,248,615 927,677
------------------- ------------------ ----------------- -----------------
Total Revenues................. $ 20,632,570 $ 15,806,085 $ 39,501,941 $ 31,409,966
=================== ================== ================= =================
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11. COMMON STOCK
During the six months ended January 31, 2008, stock options for the
purchase of 60,695 shares of the Company's common stock were exercised at
prices between $3.94 and $13.93 per share resulting in proceeds of
$523,000. During the six months ended January 31, 2007, stock options for
the purchase of 12,557 shares of the Company's common stock were exercised
at prices between $3.94 and $10.63 per share resulting in proceeds of
$62,000.
During the six months ended January 31, 2008 and 2007, we issued 12,952
and 14,900 shares in connection with our employee stock purchase plan.
On August 8, 2007, we issued 67,470 shares of restricted stock to
management and executives as part of the fiscal 2007 management incentive
program. The fair market value of the restricted stock was $688,000. The
restricted stock vests over four years or earlier if the stock price closes
at $12.23, $14.67, $17.63 and $20.38, respectively, for twenty consecutive
trading days. The accelerated vesting occurs at the appreciated stock
prices in four equal installments. The stock price closed at greater than
$12.23 for twenty consecutive trading days on October 9, 2007. The first
quarterly installment vested at this time at a price $14.29. Accordingly,
$283,000 was expensed in the six months ended January 31, 2008 as
compensation expense. We cancelled 5,544 shares of restricted stock due to
the management and executives electing to receive fewer shares in lieu of
paying the withholding taxes. In January 2008, 3,168 shares of restricted
stock was issued to the Board of Directors as part of their normal
compensation. These shares of restricted stock will vest in one year.
On August 15, 2006, we issued 63,390 shares of restricted stock to
executives and key management as part of the fiscal 2006 management
incentive program. The fair market value of the restricted stock was
$549,000. The restricted stock vests over four years or earlier if the
stock price closes at $11.26 or greater for twenty consecutive trading
days. On December 22, 2006 the restricted stock vested due to the Company's
stock price closing for the twentieth consecutive day greater than $11.26.
In the six months ended January 31, 2007, $567,500 was expensed as
compensation expense. We cancelled 20,684 shares of restricted stock due to
the executives and key management electing to receive fewer shares in lieu
of paying the withholding taxes. In January 2007, 3,174 shares of
restricted stock was issued to the Board of Directors as part of their
normal compensation. These restricted stock will vest in one year.
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During the six months ended January 31, 2008 and 2007, there were no stock
repurchases.
12. ACCRUED WARRANTY COSTS
We estimate the amount of warranty claims on sold product that may be
incurred based on current and historical data. The actual warranty expense
could differ from the estimates made by the Company based on product
performance. The following table presents the changes in our product
warranty liability:
Accrued warranty costs at July 31, 2007............................ $ 142,500
Payments made for warranty costs................................... (372,700)
Accrual for product costs.......................................... 437,700
-------------------
Accrued warranty costs at January 31, 2008......................... $ 207,500
===================
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13. SUBSEQUENT EVENT
Effective February 11, 2008, we signed a definitive Agreement and Plan of
Merger with MEDRAD, Inc., a subsidiary of Bayer AG, and with Phoenix
Acquisition, Inc., a subsidiary of MEDRAD formed to facilitate the
transaction, pursuant to which Phoenix commenced a tender offer for all of
our outstanding common stock at a price of $19.50 per share on February 25,
2008. The tender offer is scheduled to terminate on March 25, 2008, and
assuming that the conditions to acceptance of tendered shares are
satisfied, including the condition that at least two-thirds of our shares
on a fully diluted basis are tendered, Phoenix will accept the tendered
shares, and the tender offer will be followed by a merger under which we
will become a wholly-owned subsidiary of MEDRAD. Completion of the tender
offer and the merger are subject to a number of conditions in addition to
the minimum tender condition, including the receipt of, or passage of time
requirements for, regulatory and governmental approvals, and the absence of
any material adverse change in our business.