CRITICARE
SYSTEMS, INC.
Condensed
Notes to Consolidated Financial Statements
(Unaudited)
1.
Basis of Presentation
The
accompanying unaudited financial statements have been prepared by Criticare
Systems, Inc. (the "Company") pursuant to the rules and regulations of
the
Securities and Exchange Commission ("SEC") and, in the opinion of the Company,
include all adjustments necessary for a fair statement of results for each
period shown. Certain information and footnote disclosures normally included
in
financial statements prepared in accordance with generally accepted accounting
principles have been condensed or omitted pursuant to such SEC rules and
regulations. The Company believes that the disclosures made are adequate
to
prevent the financial information given from being misleading. It is suggested
that these financial statements be read in conjunction with the financial
statements and notes thereto included in the Company's latest annual report
and
previously filed Form 10-K. The three month results represent past performance,
and are not necessarily indicative of results for an entire year. Certain
amounts from the fiscal 2006 financial statements have been reclassified
to
conform to the 2007 presentation.
2.
Inventory Valuation
Inventory
is stated at the lower of cost or market, with cost determined on the first-in,
first-out method. Components of inventory consisted of the following at
September 30, 2006 and June 30, 2006, respectively:
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September
30, 2006
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|
June
30, 2006
|
|
|
|
|
|
|
|
|
|
Component
parts
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|
$
|
4,183,936
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|
$
|
2,605,751
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|
Work
in process
|
|
|
1,949,271
|
|
|
1,470,893
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|
Finished
units
|
|
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3,580,228
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|
|
5,747,393
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|
Total
inventories
|
|
|
9,713,435
|
|
|
9,824,037
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|
Less:
reserve for obsolescence
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|
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402,000
|
|
|
360,000
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|
Net
inventory
|
|
$
|
9,311,435
|
|
$
|
9,464,037
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|
3.
Property, Plant and Equipment
Property,
plant and equipment consist of the following:
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September
30, 2006
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June
30, 2006
|
|
|
|
|
|
|
|
|
|
Machinery
and equipment
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|
$
|
3,191,090
|
|
$
|
3,157,328
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|
Furniture
and fixtures
|
|
|
954,051
|
|
|
894,451
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|
Leasehold
improvements
|
|
|
243,604
|
|
|
243,604
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|
Production
tooling
|
|
|
2,321,885
|
|
|
2,294,360
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|
Demonstration
and loaner monitors
|
|
|
2,005,434
|
|
|
1,997,844
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|
Property,
plant and equipment - cost
|
|
|
8,716,064
|
|
|
8,645,329
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|
Less:
accumulated depreciation
|
|
|
(6,343,240
|
)
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|
(6,193,015
|
)
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Property,
plant and equipment - net
|
|
$
|
2,372,824
|
|
$
|
2,452,314
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|
4.
Stock Options
The
Company has adopted the fair value recognition provisions of SFAS No. 123
(R),
“Share-Based Payment”. Under the modified prospective method of adoption
selected by the Company, compensation cost recognized is the same as that
which
would have been recognized had the recognition provisions of SFAS No. 123
been
applied from its original effective date. Stock-based employee compensation
expense included in reported net income totaled $29,467 and $40,017 for
the
three months ended September 30, 2006 and 2005, respectively.
The
Company did not grant any options for the three months ended September
30, 2006.
The fair value of stock options used to compute net income per share is
the
estimated fair value at the grant date using the Black-Scholes option-pricing
model. The assumptions used when calculating the option-pricing model include;
the expected volatility of Critcare’s common stock at 45.0%, the risk-free
interest rate of 4.29%, the expected option life of 8.88 years and the
forfeiture rate of option grants at 0%.
5.
Income Taxes
No
income
tax provision has been made in the consolidated statements of operations
due to
federal and state net operating loss carry forwards that will be utilized
to
offset taxable income earned. At September 30, 2006, the Company had federal
net
operating loss carry forwards of approximately $17,706,000 (which expire
from
2008 through 2026) and state net operating loss carry forwards of approximately
$11,930,000 (which expire from 2007 through 2021) available to offset future
taxable income. The Company has recorded a valuation allowance to offset
the
related deferred income tax assets arising from these net operating loss
carry
forwards due to the uncertainty of realizing the benefits of these assets
in
future years.
6.
Line of Credit Facility
At
September 30, 2006, the Company had a $2,000,000 demand line of credit
facility
with a commercial bank to meet its short-term borrowing needs. Borrowings
against the line were payable on demand with interest payable monthly at
the
bank's reference rate, less 0.25% (8.00% as of September 30, 2006). As
of
September 30, 2006 and June 30, 2006, there were no borrowings against
the line.
Borrowings under the line of credit facility are collateralized by substantially
all assets of the Company. The credit facility has covenants which require
minimum income or liquidity levels. The Company was in compliance with
the
covenants at September 30, 2006.
7.
Net Income Per Common Share
Basic
net
income per share is computed using the weighted average number of common
shares
outstanding during the periods. Diluted net income per share is computed
using
the weighted average number of common and dilutive common equivalent shares
outstanding during the periods. Additionally, antidilution occurs when
the
exercise price of the option is higher than the average market price of
the
common stock. The diluted weighted average common shares outstanding would
be
higher by 76,250 shares for the three months ended September 30, 2006 and
by
27,000 shares for the three months ended September 30, 2005 without this
anti-dilutive impact.
CRITICARE
SYSTEMS, INC.
Management's
Discussion and Analysis of
Results
of Operations and Financial Condition
Three
Months Ended September 30, 2006 and 2005
Results
of Operations
Net
sales
of $8,206,595 for the three months ended September 30, 2006 increased 7.0%
from
$7,672,313 for the same period in fiscal 2006. A 35.4% increase in the
accessory
sales and an 8.2% increase in the number of units shipped were partially
offset
by a 3.4% reduction in average sales price, due to variations in the product
mix, in the current period. The increased sales were the result of a $859,569
increase in domestic alternate care sales and $318,363 in domestic acute
care
sales, which was partially offset by a $514,922 decrease in international
sales.
The
gross
profit percentage of 38.0% for the three months ended September 30, 2006
decreased slightly from 38.2% for the same period in fiscal 2006. The decreased
margins in the current period were mainly due to the small variations in
the
product mix.
Operating
expenses for the three months ended September 30, 2006 decreased $83,600
from
the same period in fiscal 2006. The decrease of $190,713 in sales and marketing
expenses was due mainly to a $104,619 decrease in the advertising, trade
shows
and sales promotion expenses and a $74,054 decrease in India operation
expenses
for the three months ended September 30, 2006. Administrative expenses
increased
by $91,481 due to the $91,540 of expenses incurred during the quarter in
connection with the BlueLine consent solicitation. There will be additional
expenses incurred in connection with the BlueLine consent solicitation
which
will increase the administrative expenses in the second quarter of fiscal
2007.
Total
other income for the three months ended September 30, 2006 decreased $73,875
from the same period in fiscal 2006. This decrease was mainly due to decreased
royalty income received during the quarter.
The
net
income of $332,876 for the three months ended September 30, 2006 as compared
to
net income of $137,378 for the same period in fiscal 2006, was the result
of a
$185,773 increase in gross profit combined with the decreased operating
expenses
of $83,600, partially offset by the decrease in other income of
$73,875.
CRITICARE
SYSTEMS, INC.
Management's
Discussion and Analysis of
Results
of Operations and Financial Condition
Liquidity
and Capital Resources
As
of
September 30, 2006, the Company had a cash balance of $2,675,450, which
was
$1,118,331 lower than its balance at June 30, 2006 of $3,793,781. The Company
continues to maintain a long-term bank debt free balance sheet since August
30,
2002 when it sold its building and used the proceeds from the sale to retire
the
long-term bank debt on the facility.
The
Company’s cash position decreased by $1,118,331 for the three months ended
September 30, 2006 mainly due to $1,042,826 of cash used in operations
activities and $63,144 of capital expenditures. Cash used in operations
was
$1,042,826 for the three months ended September 30, 2006 as an increase
of
$2,255,517 in receivables (mainly due to increased sales near quarter end)
was
partially offset by a $491,363 increase in accounts payable, a $121,578
decrease
in inventory, depreciation of $131,658 and net income of $332,876.
The
Company believes all future capital and liquidity requirements will be
satisfied
by cash generated from operations, proceeds received from the issuance
of common
stock related to the exercise of stock options, and its current cash balances.
No major capital equipment expenditures are expected in the Company’s current
fiscal year ending June 30, 2007. The Company also has a $2,000,000 line
of
credit currently in place that could be utilized, if necessary. At both
September 30, 2006 and June 30, 2007, there were no borrowings outstanding
under
this line of credit. The credit facility has covenants that require minimum
income or liquidity levels. The Company was in compliance with the covenants
at
September 30, 2006. This line expires in June 2007.
Forward
Looking Statements
A
number
of the matters and subject areas discussed in this report that are not
historical or current facts deal with potential future circumstances and
developments. These include anticipated product introductions, expected
future
financial results, liquidity needs, financing ability, management's or
the
Company's expectations and beliefs and similar matters discussed in Management's
Discussion and Analysis or elsewhere in
this
report. These statements may be identified by the use of forward-looking
words
or phrases such as "anticipate," "believe," "could," "expect," "intend,"
"may,"
"hope," "plan," "potential," "should," "estimate," "predict," "continue,"
"future," "will," "would" or the negative of these terms or other words
of
similar meaning.
Such
forward-looking statements are inherently subject to known and unknown
risks and
uncertainties. The Company's actual results and future developments could
differ
materially from the results or developments expressed in, or implied by,
these
forward-looking statements. Factors that may cause actual results to differ
materially from those contemplated by such forward-looking statements
include,
but are not limited to, general economic conditions, demand for the Company's
products, costs of operations, the development of new products, the reliance
on
single sources of supply for certain components in the Company's products,
government regulation, health care cost containment
programs, the effectiveness of the Company's programs to manage working
capital
and reduce costs, competition in the Company's markets, compliance with
product
safety regulations and product liability and product recall risks, risks
relating to international sales and compliance with U.S. export regulations,
unanticipated difficulties in outsourcing the manufacturing of the majority
of
its products to foreign manufacturers and risks related to foreign
manufacturing, including economic and political instability, trade and
foreign
tax laws, production delays and cost overruns and quality control. Such
uncertainties and other risks that may affect the Company's performance
are
discussed further in Part I, Item 1A, "Risk Factors," in the Company's
Form 10-K
for the year ended June 30, 2006. The Company undertakes no obligation
to make
any revisions to the forward-looking statements contained in this report
or to
update them to reflect events or circumstances occurring after the date
of this
report.
Quantitative
and Qualitative Disclosures about Market Risk
The
Company has a demand line of credit facility with a commercial bank with
interest payable monthly at 25 basis points below the bank's reference
rate. The
Company had no borrowings outstanding under this bank facility at September
30,
2006 and June 30, 2006. Due historically to the lack of need to borrow
from this
credit facility and due to the Company’s current cash position, the Company is
not subject to financial risk on this obligation if interest rates in the
market
change significantly.
The
Company’s net sales are primarily denominated in United States dollars, except
for a small amount of net sales from the Company’s operation in India
denominated in Indian rupees. As a result, part of the Company’s accounts
receivable are denominated in rupees and translated into U.S. dollars for
financial reporting purposes. A 10% change in the exchange rate of the
U.S.
dollar with respect to the Indian rupee would not have a material adverse
effect
on the Company’s financial condition or results of operations for the quarter
ended September 30, 2006. The Company does not use any hedges or other
derivative financial instruments to manage or reduce exchange rate
risk.
Controls
and Procedures
As
of the
end of the period covered by this report, the Company carried out an evaluation,
under the supervision and with the participation of the Company’s management,
including the Company’s Chief Executive Officer and the Company’s Vice President
- Finance, of the Company’s disclosure controls and procedures (as defined in
Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934,
as
amended). Based on this evaluation, the Company’s Chief Executive Officer and
Vice President - Finance concluded that, as of the end of such period,
the
Company’s disclosure controls and procedures were effective in recording,
processing, summarizing and reporting, on a timely basis, information required
to be disclosed by the Company in reports that the Company files with or
submits
to the Securities and Exchange Commission. It should be noted that in designing
and evaluating the disclosure controls and procedures, management recognized
that any controls and procedures, no matter how well designed and operated,
can
provide only reasonable assurance of achieving the desired control objectives,
and management necessarily was required to apply its judgment in evaluating
the
cost-benefit relationship of possible controls and procedures. The Company
has
designed its disclosure controls and procedures to reach a level of reasonable
assurance of achieving the desired control objectives and based upon the
evaluation described above, the Company’s Chief Executive Officer and Vice
President -Finance concluded that the Company’s disclosure controls and
procedures were effective at reaching that level of reasonable
assurance.
There
was
no change in the Company’s internal control over financial reporting (as defined
in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934,
as
amended) during the Company’s most recently completed fiscal quarter that has
materially affected, or is reasonably likely to materially affect, the
Company’s
internal control over financial reporting.
PART
II -
OTHER INFORMATION
Item
1A. Risk Factors.
There
have been no material changes from the risk factors previously disclosed
in Part
I, Item 1A, "Risk Factors," of the Company's Form 10-K for the year ended
June
30, 2006. Please refer to that section for disclosures regarding the risks
and
uncertainties relating to the Company's business.
Item
5. Other Information.
On
October 19, 2006, the Company issued a press release announcing its preliminary
unaudited revenue for the first quarter of fiscal 2007, but has not previously
furnished a Form 8-K with respect to such press release pursuant to Item
2.02 of
Form 8-K. A copy of the press release is attached as Exhibit 99.1 to this
report. The attached Exhibit 99.1 shall not be deemed "filed" for purposes
of
Section 18 of the Securities Exchange Act of 1934, nor shall it be deemed
incorporated by reference in any filing under the Securities Act of 1933
or the
Securities Exchange Act of 1934, except as shall be expressly set forth
by
specific reference in such filing.
Effective
November 10, 2006, the Company entered into an amended and restated
employment agreement with Deborah A. Zane, Vice President-Marketing and
Business Development. The following discussion of the employment agreement
is
qualified in its entirety by reference to the employment agreement, which
is
attached as Exhibit 10.1 to this report.
The
agreement provides that Ms. Zane will continue to receive her current
compensation, with an annual review of the compensation within 30 days
prior to the end of each fiscal year. Ms. Zane is entitled to receive
health and life insurance coverage and disability insurance. The Company
may
terminate Ms. Zane's employment at any time and Ms. Zane may resign at
any time. If the Company terminates her employment without cause at any
time
either prior to or after a change in control of the Company, Ms. Zane is
entitled to receive payment of her base salary, commissions and her other
employee benefits for 15 months from the date of termination. If Ms. Zane's
employment is terminated for cause, or if she resigns, before a change
in
control of the Company, she will not be entitled to receive any base salary
or
other benefits for periods after the termination date.
Ms. Zane
has agreed not to compete with the Company during employment and not to
solicit
customers or employees for a period of 12 months after any voluntary termination
of employment or any termination by the Company with or without cause.
Ms. Zane has agreed to maintain the confidentiality of the Company's
financial statements and other financial information.
Ms.
Zane's employment agreement provides that if the Company experiences a
change in
control, and Ms. Zane voluntarily terminates her employment for any reason
after
the change in control, Ms. Zane is entitled to receive payment of her base
salary, commissions and her other employee benefits for 15 months after the
date of termination or until Ms. Zane secures alternative employment, whichever
period is shorter. Ms. Zane's new employment agreement includes the new,
more
complete definition of a "change in control" approved for the Company's
employment agreements with its executive officers effective September 28,
2006. This definition of a "change in control" includes the following changes:
(i) a change in control now includes a change in the composition of a majority
of the board of directors of the Company (except with the approval of at
least a
majority of the incumbent directors); and (ii) a change in control will
occur
upon a change in the ownership of 50% or more (in lieu of the prior threshold
of
51% or more) of the outstanding stock or voting power of the
Company.
Item
6.
Exhibits.
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3.1
|
Restated
Certificate of Incorporation of the Company (incorporated by
reference to
the Registration Statement filed on Form S-1, Registration No.
33-13050).
|
|
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3.2
|
By-Laws
of the Company (incorporated by reference to the Registration
Statement
filed on Form S-1, Registration No.
33-13050).
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4.1
|
Specimen
Common Stock certificate (incorporated by reference to the Registration
Statement filed on Form S-1, Registration No.
33-13050).
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4.2
|
Rights
Agreement (incorporated by reference to the Company’s Current Report on
Form 8-K filed on April 18, 1997).
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10.1
|
Employment
Agreement, dated as of November 10, 2006, between the Company and
Deborah A. Zane.
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31.1
|
Certification
of Emil H. Soika, President and Chief Executive Officer (Principal
Executive Officer) pursuant to Section 302 of the Sarbanes-Oxley
Act of
2002.
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31.2
|
Certification
of Joel D. Knudson, Vice President - Finance and Secretary (Principal
Financial Officer) pursuant to Section 302 of the Sarbanes-Oxley
Act of
2002.
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|
32*
|
Certification
of Principal Executive Officer and Principal Financial Officer
pursuant to
18 U.S.C. Section 1350.
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99.1*
|
Press
Release of Criticare Systems, Inc., issued October 19,
2006.
|
__________________
*
This
Exhibit is not “filed” for purposes of Section 18 of the Securities Exchange Act
of 1934, as amended, or incorporated by reference into any filing under the
Securities Act of 1933, as amended, or the Securities Exchange Act of 1934,
as
amended.