Unassociated Document
UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington,
DC 20549
FORM
10-Q
(Mark
One)
x
|
QUARTERLY
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITES EXCHANGE ACT OF
1934
|
|
For
the quarterly period ended June 30,
2010
|
¨
|
TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
|
|
For
the transition period from ____________ to ____________
|
|
|
|
Commission
file number 1-31070
|
Derma
Sciences, Inc.
(Exact
name of registrant as specified in its charter)
Pennsylvania
|
|
23-2328753
|
(State
or other jurisdiction of Incorporation)
|
|
(IRS
employer identification number)
|
214
Carnegie Center, Suite 300
Princeton,
NJ 08540
(Address
of principal executive offices)
(609)
514-4744
(Issuer’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 Securities Exchange Act of 1934 during the
preceding 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.
Yes x No ¨
Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding
12 months (or for such shorter period that the registrant was required to submit
and post such files).
Yes ¨ No ¨
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting
company. See the definitions of “large accelerated filer,”
“accelerated filer” and “smaller reporting company” in Rule 12b-2 of the
Exchange Act.
Large
accelerated filer
|
¨
|
Accelerated
filer
|
¨
|
Non-accelerated
filer
|
¨ (Do
not check if a smaller reporting company)
|
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 ¨ No x
Indicate
the number of shares outstanding of each of the issuer's classes of common
stock, as of the latest practicable date.
Date: August
12, 2010
|
Class:
Common Stock, par value $.01 per share
|
|
|
Shares Outstanding: 6,561,826
|
|
PART
I – FINANCIAL INFORMATION
DERMA
SCIENCES, INC.
FORM
10-Q
INDEX
Description
|
|
Page
|
|
|
|
Part
I – Financial Information
|
|
2
|
|
|
|
Item
1. Financial Statements
|
|
2
|
|
|
|
Condensed
Consolidated Balance Sheets – June 30, 2010 (Unaudited) and December 31,
2009
|
|
3
|
|
|
|
Condensed
Consolidated Statements of Operations – Three months ended June 30, 2010
and June 30, 2009 (Unaudited)
|
|
4
|
|
|
|
Condensed
Consolidated Statements of Operations – Six months ended June 30, 2010 and
June 30, 2009 (Unaudited)
|
|
5
|
|
|
|
Condensed
Consolidated Statements of Cash Flows – Six months ended June 30, 2010 and
June 30, 2009 (Unaudited)
|
|
6
|
|
|
|
Notes
to Condensed Consolidated Financial Statements (Unaudited)
|
|
7
|
|
|
|
Item
2. Management’s Discussion and Analysis of Financial Condition
and Results of Operations
|
|
16
|
|
|
|
Item
4. Controls and Procedures
|
|
28
|
|
|
|
Part
II - Other Information
|
|
29
|
|
|
|
Item
1A. Risk Factors
|
|
29
|
|
|
|
Item
6. Exhibits
|
|
30
|
Forward Looking
Statements
This
document includes certain “forward-looking statements” within the meaning of the
Private Securities Litigation Reform Act of 1995. These statements
are based on management’s current expectations and are subject to uncertainty
and changes in circumstances. Actual results may differ materially
from these expectations due to changes in political, economic, business,
competitive, market and regulatory factors.
Part
I – Financial Information
Item
1. FINANCIAL STATEMENTS
DERMA
SCIENCES, INC. AND SUBSIDIARIES
Condensed
Consolidated Balance Sheets
|
|
June
30,
|
|
|
|
|
|
|
2010
|
|
|
December 31,
|
|
|
|
(Unaudited)
|
|
|
2009
|
|
ASSETS
|
|
|
|
|
|
|
Current
Assets
|
|
|
|
|
|
|
Cash
and cash equivalents
|
|
$ |
385,424 |
|
|
$ |
243,524 |
|
Accounts
receivable, net
|
|
|
4,679,530 |
|
|
|
3,372,712 |
|
Inventories
|
|
|
14,004,377 |
|
|
|
11,489,724 |
|
Prepaid
expenses and other current assets
|
|
|
431,058 |
|
|
|
456,675 |
|
Total
current assets
|
|
|
19,500,389 |
|
|
|
15,562,635 |
|
Cash
– restricted
|
|
|
- |
|
|
|
2,032,164 |
|
Equipment
and improvements, net
|
|
|
3,364,131 |
|
|
|
3,741,347 |
|
Goodwill
|
|
|
7,119,726 |
|
|
|
7,119,726 |
|
Other
intangible assets, net
|
|
|
7,695,950 |
|
|
|
3,994,250 |
|
Other
assets, net
|
|
|
365,409 |
|
|
|
849,753 |
|
Total
Assets
|
|
$ |
38,045,605 |
|
|
$ |
33,299,875 |
|
LIABILITIES
AND SHAREHOLDERS’ EQUITY
|
|
|
|
|
|
|
|
|
Current
Liabilities
|
|
|
|
|
|
|
|
|
Line
of credit borrowings
|
|
|
4,107,476 |
|
|
|
2,306,306 |
|
Current
maturities of long-term debt
|
|
|
23,009 |
|
|
|
1,759,185 |
|
Accounts
payable
|
|
|
3,983,431 |
|
|
|
3,363,096 |
|
Accrued
expenses and other current liabilities
|
|
|
2,121,591 |
|
|
|
1,342,467 |
|
Total
current liabilities
|
|
|
10,235,507 |
|
|
|
8,771,054 |
|
Long-term
debt
|
|
|
- |
|
|
|
2,305,851 |
|
Other
long-term liabilities
|
|
|
78,351 |
|
|
|
96,564 |
|
Deferred
tax liability
|
|
|
312,670 |
|
|
|
355,349 |
|
Total
Liabilities
|
|
|
10,626,528 |
|
|
|
11,528,818 |
|
Shareholders’
Equity
|
|
|
|
|
|
|
|
|
Convertible
preferred stock, $.01 par value; 1,468,750 shares authorized; issued and
outstanding: 284,844 shares (liquidation preference of
$4,201,426 at June 30, 2010)
|
|
|
2,848 |
|
|
|
2,851 |
|
Common
stock, $.01 par value; 18,750,000 authorized; issued and outstanding:
6,561,826 at June 30, 2010; 5,039,468 at December 31, 2009
|
|
|
65,618 |
|
|
|
50,395 |
|
Additional
paid-in capital
|
|
|
48,393,839 |
|
|
|
41,221,613 |
|
Accumulated
other comprehensive income – cumulative translation
adjustments
|
|
|
1,231,626 |
|
|
|
1,303,293 |
|
Accumulated
deficit
|
|
|
(22,274,854 |
) |
|
|
(20,807,095 |
) |
Total
Shareholders’ Equity
|
|
|
27,419,077 |
|
|
|
21,771,057 |
|
Total
Liabilities and Shareholders’ Equity
|
|
$ |
38,045,605 |
|
|
$ |
33,299,875 |
|
See
accompanying consolidated notes.
DERMA
SCIENCES, INC. AND SUBSIDIARIES
Condensed
Consolidated Statements of Operations (Unaudited)
|
|
Three
Months ended June 30,
|
|
|
|
2010
|
|
|
2009
|
|
Net
Sales
|
|
$ |
13,230,106 |
|
|
$ |
11,563,341 |
|
Cost
of sales
|
|
|
9,202,202 |
|
|
|
8,135,574 |
|
Gross
Profit
|
|
|
4,027,904 |
|
|
|
3,427,767 |
|
Operating
Expenses
|
|
|
|
|
|
|
|
|
Selling,
general and administrative
|
|
|
4,689,774 |
|
|
|
3,703,038 |
|
Research
and development
|
|
|
123,744 |
|
|
|
87,580 |
|
Total
operating expenses
|
|
|
4,813,518 |
|
|
|
3,790,618 |
|
Operating
loss
|
|
|
(785,614 |
) |
|
|
(362,851 |
) |
Other
expense, net:
|
|
|
|
|
|
|
|
|
Interest
expense
|
|
|
134,707 |
|
|
|
239,600 |
|
Other
income
|
|
|
(68,625 |
) |
|
|
(42,252 |
) |
Total
other expense
|
|
|
66,082 |
|
|
|
197,348 |
|
Loss
before provision for income taxes
|
|
|
(851,696 |
) |
|
|
(560,199 |
) |
Provision
for income taxes
|
|
|
81,159 |
|
|
|
303 |
|
Net
Loss
|
|
$ |
(932,855 |
) |
|
$ |
(560,502 |
) |
Net
loss per common share – basic and diluted
|
|
$ |
(0.14 |
) |
|
$ |
(0.11 |
) |
Shares
used in computing net loss per common share – basic
and diluted
|
|
|
6,558,562 |
|
|
|
5,029,372 |
|
See
accompanying consolidated notes.
DERMA
SCIENCES, INC. AND SUBSIDIARIES
Condensed
Consolidated Statements of Operations (Unaudited)
|
|
Six
Months ended June 30,
|
|
|
|
2010
|
|
|
2009
|
|
Net
Sales
|
|
$ |
26,074,487 |
|
|
$ |
21,995,232 |
|
Cost
of sales
|
|
|
18,021,184 |
|
|
|
15,213,830 |
|
Gross
Profit
|
|
|
8,053,303 |
|
|
|
6,781,402 |
|
Operating
Expenses
|
|
|
|
|
|
|
|
|
Selling,
general and administrative
|
|
|
8,913,019 |
|
|
|
7,567,164 |
|
Research
and development
|
|
|
239,851 |
|
|
|
217,926 |
|
Total
operating expenses
|
|
|
9,152,870 |
|
|
|
7,785,090 |
|
Operating
loss
|
|
|
(1,099,567 |
) |
|
|
(1,003,688 |
) |
Other
expense, net:
|
|
|
|
|
|
|
|
|
Interest
expense
|
|
|
294,599 |
|
|
|
411,070 |
|
Loss
on debt extinguishment
|
|
|
114,072 |
|
|
|
- |
|
Other
income
|
|
|
(178,131 |
) |
|
|
(43,789 |
) |
Total
other expense
|
|
|
230,540 |
|
|
|
367,281 |
|
Loss
before provision (benefit) for income taxes
|
|
|
(1,330,107 |
) |
|
|
(1,370,969 |
) |
Provision
(benefit) for income taxes
|
|
|
137,652 |
|
|
|
(52,388 |
) |
Net
Loss
|
|
$ |
(1,467,759 |
) |
|
$ |
(1,318,581 |
) |
Net
loss per common share – basic and diluted
|
|
$ |
(0.24 |
) |
|
$ |
(0.26 |
) |
Shares
used in computing net loss per common share – basic
and diluted
|
|
|
6,105,386 |
|
|
|
5,023,515 |
|
See
accompanying consolidated notes.
DERMA
SCIENCES, INC. AND SUBSIDIARIES
Condensed
Consolidated Statements of Cash Flows (Unaudited)
|
|
Six
Months Ended June 30,
|
|
|
|
2010
|
|
|
2009
|
|
Operating
Activities
|
|
|
|
|
|
|
Net
Loss
|
|
$ |
(1,467,759 |
) |
|
$ |
(1,318,581 |
) |
Adjustments
to reconcile net loss to net cash (used in) provided by operating
activities:
|
|
|
|
|
|
|
|
|
Depreciation
of equipment and improvements
|
|
|
485,242 |
|
|
|
416,163 |
|
Amortization
of intangible assets
|
|
|
807,300 |
|
|
|
658,880 |
|
Amortization
of deferred financing costs
|
|
|
61,575 |
|
|
|
72,458 |
|
Loss
on debt extinguishment
|
|
|
114,072 |
|
|
|
- |
|
Provision
for (recovery of) bad debts
|
|
|
9,312 |
|
|
|
(62,325 |
) |
Allowance
for sales adjustments
|
|
|
(32 |
) |
|
|
386,851 |
|
Provision
for inventory obsolescence
|
|
|
247,967 |
|
|
|
115,280 |
|
Deferred
rent expense
|
|
|
(10,422 |
) |
|
|
38,534 |
|
Compensation
charge for employee stock options
|
|
|
417,130 |
|
|
|
478,842 |
|
Compensation
charge for restricted stock
|
|
|
17,067 |
|
|
|
18,148 |
|
Gain
on sale of equipment
|
|
|
- |
|
|
|
(59,031 |
) |
Deferred
income taxes
|
|
|
(38,992 |
) |
|
|
(22,704 |
) |
Changes
in operating assets and liabilities:
|
|
|
|
|
|
|
|
|
Accounts
receivable
|
|
|
(1,316,098 |
) |
|
|
396,033 |
|
Inventories
|
|
|
(2,758,137 |
) |
|
|
957,665 |
|
Prepaid
expenses and other current assets
|
|
|
22,005 |
|
|
|
44,824 |
|
Other
assets
|
|
|
310,662 |
|
|
|
(299 |
) |
Accounts
payable
|
|
|
615,278 |
|
|
|
(1,034,217 |
) |
Accrued
expenses and other current liabilities
|
|
|
737,782 |
|
|
|
(895,339 |
) |
Other
long-term liabilities
|
|
|
(4,092 |
) |
|
|
7,310 |
|
Net
cash (used in) provided by operating activities
|
|
|
(1,750,140 |
) |
|
|
198,492 |
|
Investing
Activities
|
|
|
|
|
|
|
|
|
Purchase
of equipment and improvements
|
|
|
(139,236 |
) |
|
|
(113,200 |
) |
Purchase
of intangible asset
|
|
|
(2,250,000 |
) |
|
|
- |
|
Proceeds
from sale of equipment
|
|
|
- |
|
|
|
61,000 |
|
Net
cash used in investing activities
|
|
|
(2,389,236 |
) |
|
|
(52,200 |
) |
Financing
Activities
|
|
|
|
|
|
|
|
|
Net
change in bank line of credit
|
|
|
1,801,170 |
|
|
|
334,776 |
|
Long-term
debt repayments
|
|
|
(4,042,027 |
) |
|
|
(652,957 |
) |
Net
change in restricted cash
|
|
|
2,032,164 |
|
|
|
(11,300 |
) |
Proceeds
from issuance of stock, net of costs
|
|
|
4,491,279 |
|
|
|
(5,000 |
) |
Net
cash provided by (used in) financing activities
|
|
|
4,282,586 |
|
|
|
(334,481 |
) |
Effect
of exchange rate changes on cash
|
|
|
(1,310 |
) |
|
|
(35,809 |
) |
Net
increase (decrease) in cash and cash equivalents
|
|
|
141,900 |
|
|
|
(223,998 |
) |
Cash
and cash equivalents
|
|
|
|
|
|
|
|
|
Beginning
of period
|
|
|
243,524 |
|
|
|
391,038 |
|
End
of period
|
|
$ |
385,424 |
|
|
$ |
167,040 |
|
Supplemental
disclosures of cash flow information:
|
|
|
|
|
|
|
|
|
Issuance
of common stock and warrants for purchase of intangible
asset
|
|
$ |
2,259,000 |
|
|
$ |
- |
|
Cash
paid during the period for:
|
|
|
|
|
|
|
|
|
Interest
|
|
$ |
257,685 |
|
|
$ |
303,613 |
|
See
accompanying consolidated notes.
DERMA
SCIENCES, INC. AND SUBSIDIARIES
Notes to
Condensed Consolidated Financial Statements (Unaudited)
1.
|
Organization
and Summary of Significant Accounting
Policies
|
Derma
Sciences, Inc. and its subsidiaries (the “Company”) is a full line provider of
wound care, wound closure and specialty securement devices and skin care
products. The Company markets its products principally through
independent distributors servicing the long-term care, home health and acute
care markets in the United States, Canada and other select international
markets. The Company’s U.S. distribution facilities are located in
St. Louis, Missouri and Houston, Texas, while the Company’s Canadian
distribution facility is located in Toronto. The Company has
manufacturing facilities in Toronto, Canada and Nantong, China.
Basis of Presentation
The accompanying unaudited condensed
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
8 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
adjustments) considered necessary for a fair presentation have been
included. Operating results for the six months ended June 30, 2010,
are not necessarily indicative of the results that may be expected for the year
ending December 31, 2010. Information included in the condensed
balance sheet as of December 31, 2009 has been derived from the consolidated
financial statements and footnotes thereto for the year ended December 31, 2009,
included in Form 10-K previously filed with the Securities and Exchange
Commission. For further information, refer to that Form
10-K.
Reverse Stock Split – The
accompanying financial statements reflect a 1-for-8 reverse split of the
Company’s common and preferred stock approved by the board of directors and
stockholders of the Company and made effective by an amendment to the Company’s
articles of incorporation on February 1, 2010. All share and per
share information herein that relates to the Company’s common and preferred
stock has been retroactively restated to reflect the reverse stock
split.
Net Loss per Share – Net loss
per common share – basic is computed by dividing net loss by the weighted
average number of common shares outstanding for the period. Net loss
per common share – diluted reflects the potential dilution of earnings by
including the effects of the assumed exercise, conversion or issuance of
potentially issuable shares of common stock (“potentially dilutive securities”),
including those attributable to stock options, warrants, convertible preferred
stock and restricted common stock in the weighted average number of common
shares outstanding for a period, if dilutive. The effects of the
assumed exercise of warrants and stock options are determined using the treasury
stock method. Potentially dilutive securities have not been included
in the computation of diluted loss per share for the three and six months ended
June 30, 2010 and 2009 as the effect would be anti-dilutive.
Potentially
dilutive shares excluded as a result of the effects being anti-dilutive are as
follows:
|
|
2010
|
|
|
2009
|
|
Dilutive
shares:
|
|
|
|
|
|
|
Convertible
preferred stock
|
|
|
284,844 |
|
|
|
285,051 |
|
Restricted
common stock
|
|
|
20,000 |
|
|
|
- |
|
Warrants
|
|
|
1,734,531 |
|
|
|
1,099,407 |
|
Stock
options
|
|
|
1,282,975 |
|
|
|
1,176,953 |
|
|
|
|
|
|
|
|
|
|
Total
dilutive shares
|
|
|
3,322,350 |
|
|
|
2,561,411 |
|
DERMA
SCIENCES, INC. AND SUBSIDIARIES
Notes to
Condensed Consolidated Financial Statements (Unaudited)
Inventories
include the following:
|
|
June 30,
2010
|
|
|
December 31,
2009
|
|
|
|
|
|
|
|
|
Finished
goods
|
|
$ |
9,078,185 |
|
|
$ |
7,804,339 |
|
Work
in process
|
|
|
833,283 |
|
|
|
466,365 |
|
Packaging
materials
|
|
|
929,016 |
|
|
|
722,148 |
|
Raw
materials
|
|
|
3,163,893 |
|
|
|
2,496,872 |
|
|
|
|
|
|
|
|
|
|
Total
inventory
|
|
$ |
14,004,377 |
|
|
$ |
11,489,724 |
|
3.
|
Line
of Credit Borrowings
|
In
November 2007, the Company entered into a five-year revolving credit agreement
providing for maximum borrowings of $8,000,000 with a U.S.
lender. The revolving credit agreement was amended from time to time,
the latest of which was March 26, 2010. Advances under the revolving
credit agreement, as amended may be drawn, up to 85% of eligible
receivables (as defined) and 44% of eligible inventory (as defined) less a
minimum excess availability reserve of $1,000,000. Interest on
outstanding advances under the amended revolving credit agreement is payable at
the three month LIBOR rate subject to a 1.50% floor plus 4.25%
.. In addition, the Company pays a monthly unused line fee of
0.5% per annum on the difference between the daily average amount of advances
outstanding under the amended agreement and $8,000,000 together with a monthly
collateral management fee of $2,000. At June 30, 2010 the effective
interest rate was 5.75% and the outstanding balance was $4,107,476.
Outstanding
balances under the amended agreement are secured by all of the Company’s and its
subsidiaries’ existing and after-acquired tangible and intangible assets located
in the United States and Canada.
The
revolving credit agreement, as amended, is subject to financial covenants which
require maintaining a minimum of fixed charge coverage and total leverage ratios
(as defined). Additional covenants governing permitted investments,
indebtedness and liens, together with payments of dividends and protection of
collateral, are also included in the agreement. The amended revolving
credit agreement contains a subjective acceleration provision whereby the lender
can declare a default upon a material adverse change in the Company’s business
operations.
Long-term debt consists of the
following:
|
|
June 30,
2010
|
|
|
December
31,
2009
|
|
|
|
|
|
|
|
|
|
|
U.S.
term loan
|
|
$ |
- |
|
|
$ |
3,500,000 |
|
Promissory
note
|
|
|
- |
|
|
|
500,000 |
|
Capital
lease obligation
|
|
|
23,009 |
|
|
|
65,036 |
|
|
|
|
|
|
|
|
|
|
Total
debt
|
|
|
23,009 |
|
|
|
4,065,036 |
|
|
|
|
|
|
|
|
|
|
Less: current
maturities
|
|
|
23,009 |
|
|
|
1,759,185 |
|
|
|
|
|
|
|
|
|
|
Long-term
debt
|
|
$ |
- |
|
|
$ |
2,305,851 |
|
DERMA
SCIENCES, INC. AND SUBSIDIARIES
Notes to
Condensed Consolidated Financial Statements (Unaudited)
U.S. Term Loan
In
November 2007, the Company entered into a five-year $6,000,000 term loan
agreement with a U.S. lender. On February 23, 2010 the term loan was
paid off which resulted in a $114,072 loss on debt extinguishment.
Promissory Note
In connection with an April, 2006
acquisition a portion of the purchase price was paid via a
12% unsecured promissory note issued to the seller. The
promissory note provided for quarterly interest installments of
$15,000 and a final payment of the outstanding principal balance of $500,000
plus interest. The promissory note was paid off on March 31, 2010.
Capital Lease Obligations
The Company has an outstanding capital
lease obligation for certain office furniture totaling $23,009 as of June 30,
2010. The capital lease obligation bears interest at 6.8% with the
lease term expiring in February 2011.
Preferred
Stock
There are
18,598 shares of series A convertible preferred stock outstanding at June 30,
2010. The series A preferred stock is convertible into common stock
on a one-for-one basis, bears no dividend, maintains a liquidation preference of
$32.00 per share, votes as a class on matters affecting the series A preferred
stock and maintains voting rights identical to the common stock on all other
matters.
There are
54,943 shares of series B convertible preferred stock outstanding at June 30,
2010. The series B preferred stock is convertible into common stock
on a one-for-one basis, bears no dividend, maintains a liquidation preference of
$48.00 per share, votes as a class on matters affecting the series B preferred
stock and maintains voting rights identical to the common stock on all other
matters.
There are 77,384 shares of series C
convertible preferred stock outstanding at June 30, 2010. The series
C preferred stock is convertible into common stock on a one-for-one basis, bears
no dividend, maintains a liquidation preference averaging $5.60 per share, votes
as a class on matters affecting the series C preferred stock and maintains
voting rights identical to the common stock on all other matters.
There are 133,919 shares of series D
convertible preferred stock outstanding at June 30, 2010. The series
D preferred stock is convertible into common stock on a one-for-one basis, bears
no dividend, maintains a liquidation preference averaging $4.00 per share, votes
as a class on matters affecting the series D preferred stock and maintains
voting rights identical to the common stock on all other matters.
Common
Stock
In April,
2010 the Company issued 220 common stock shares for the conversion of series A
and series B preferred stock shares and 626 shares upon the exercise of stock
options. Additionally, in June, 2010, 3,125 common stock shares were
issued upon the exercise of stock options.
In
February 2010, the Company raised $4,478,801 (net of $1,110,199 in commission
and other offering expenses) from the sale of 1,117,800 shares of common stock
at a price of $5.00 per share, together with 372,600 five-year warrants to
purchase common stock at $5.50 per share. In addition, the placement
agent received 29,160 five-year warrants to purchase common stock at $6.25 per
share. A portion of the proceeds along with restricted cash of
$2,032,164 were used to acquire the perpetual worldwide Medihoney® licensing
rights from Comvita (Note 9) and pay off the outstanding U.S. term loan balance
of $3,300,000 and the $500,000 promissory note.
DERMA
SCIENCES, INC. AND SUBSIDIARIES
Notes to
Condensed Consolidated Financial Statements (Unaudited)
Also in
February 2010, the Company issued 400,000 shares of its common stock together
with 133,333 warrants to purchase its common stock at an exercise price of $5.50
per share and 100,000 warrants to purchase its common stock at an exercise price
of $6.25 per share in connection with the purchase of the world-wide Medihoney
license rights (see Note 9).
Effective
May 12, 2009, 21,875 shares of common stock were issued to outside directors
upon vesting of compensatory restricted stock granted on May 12,
2006.
Stock Purchase Warrants
At June 30, 2010, the Company had
warrants outstanding to purchase 1,734,531 shares of the Company’s common stock
as outlined below:
Series
|
|
Number of Warrants
|
|
|
Exercise Price
|
|
Expiration Date
|
|
|
|
|
|
|
|
|
H
|
|
|
331,915 |
|
|
$ |
8.00 |
|
April
30,2011
|
I
|
|
|
94,351 |
|
|
$ |
5.76 |
|
April
30, 2011
|
J
|
|
|
267,858 |
|
|
$ |
6.16 |
|
May
31, 2013
|
K
|
|
|
399,064 |
|
|
$ |
9.60 |
|
April
1, 2013
|
L
|
|
|
6,250 |
|
|
$ |
3.12 |
|
March
31, 2014
|
N
|
|
|
100,000 |
|
|
$ |
6.25 |
|
February
22, 2015
|
O
|
|
|
372,600 |
|
|
$ |
5.50 |
|
February
22, 2015
|
P
|
|
|
29,160 |
|
|
$ |
6.25 |
|
February
16, 2015
|
Q
|
|
|
133,333 |
|
|
$ |
5.50 |
|
February
22, 2015
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
1,734,531 |
|
|
|
|
|
|
The
Company has a stock option plan under which options to purchase a maximum of
1,250,000 shares of common stock may be issued (“plan options”). The
plan permits the granting of both incentive stock options and nonqualified stock
options to employees and directors of the Company and certain outside
consultants and advisors to the Company. The option exercise price
may not be less than the fair market value of the stock on the date of the grant
of the option. The duration of each option may not exceed 10 years
from the date of grant. Plan options to purchase 236,625 and 205,000
shares of common stock were granted to officers, directors, agents and employees
during the six months ended June 30, 2010 and 2009, respectively, with exercise
prices ranging from $3.12 to $5.12 per share. During the six months
ended June 30, 2010 and 2009, 16,249 and 1,250 plan options were forfeited,
respectively, and during the six months ended June 30, 2010, 3,751 were
exercised. As of June 30, 2010, options to purchase 1,075,974 shares
of the Company’s common stock were issued and outstanding under the
plan.
The
Company has previously granted nonqualified stock options to officers,
directors, agents and employees outside of the stock option plan (“non-plan
options”). All non-plan options were granted at the fair market value
at the date of grant. During the six months ended June 30, 2009,
29,625 non-plan options expired. As of June 30, 2010, non-plan
options to purchase 207,001 shares of the Company’s common stock were issued and
outstanding.
DERMA
SCIENCES, INC. AND SUBSIDIARIES
Notes to
Condensed Consolidated Financial Statements (Unaudited)
A summary
of the Company’s stock option activity and related information for the six
months ended June 30, 2010 and 2009 follows:
|
|
2010
|
|
|
2009
|
|
|
|
Options
|
|
|
Weighted
Average
Exercise Price
|
|
|
Options
|
|
|
Weighted
Average
Exercise Price
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding
– January 1
|
|
|
1,066,350 |
|
|
$ |
5.08 |
|
|
|
1,002,828 |
|
|
$ |
5.52 |
|
Granted
|
|
|
236,625 |
|
|
$ |
5.11 |
|
|
|
205,000 |
|
|
$ |
3.04 |
|
Forfeited
|
|
|
(16,249 |
) |
|
$ |
4.43 |
|
|
|
(1,250 |
) |
|
$ |
6.00 |
|
Expired
|
|
|
- |
|
|
|
|
|
|
|
(29,625 |
) |
|
$ |
8.88 |
|
Exercised
|
|
|
(3,751 |
) |
|
$ |
3.33 |
|
|
|
- |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding
– June 30
|
|
|
1,282,975 |
|
|
$ |
5.10 |
|
|
|
1,176,953 |
|
|
$ |
5.04 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercisable
at June 30
|
|
|
988,029 |
|
|
$ |
5.22 |
|
|
|
823,828 |
|
|
$ |
5.44 |
|
During the six months ended June 30,
2010 and 2009 the fair value of each service and performance based option award
was estimated at the date of grant using the Black-Scholes option pricing
model. The weighted-average assumptions used during the three and six
months ended June 30, 2010 and 2009 were as follows:
|
|
Three Months Ended June 30,
|
|
|
Six Months Ended June 30,
|
|
|
|
2010
|
|
|
2009
|
|
|
2010
|
|
|
2009
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Risk-free
interest rate
|
|
|
2.43 |
% |
|
|
2.34 |
% |
|
|
2.56 |
% |
|
|
2.30 |
% |
Volatility
factor
|
|
|
78.6 |
% |
|
|
89.9 |
% |
|
|
79.2 |
% |
|
|
92.3 |
% |
Dividend
yield
|
|
|
0 |
% |
|
|
0 |
% |
|
|
0 |
% |
|
|
0 |
% |
Expected
option life (years)
|
|
|
6.25 |
|
|
|
6.25 |
|
|
|
6.25 |
|
|
|
6.25 |
|
Contractual
life (years)
|
|
|
10 |
|
|
|
10 |
|
|
|
10 |
|
|
|
10 |
|
In both
2010 and 2009, the risk-free rate utilized represents the U.S. Treasury yield
curve rate which approximates the risk-free rate for the expected option life at
the time of grant. In 2010 and 2009, the volatility factor was
calculated based on the seventy-five month-end closing prices of the Company’s
common stock preceding the month of stock option grant. The Company
uses a seventy-five month volatility period to coincide with the expected stock
option life. The dividend yield is 0% since the Company does not
anticipate paying dividends in the near future. Based on the
Company’s historical experience of options that expire or are cancelled before
becoming fully vested, the Company assumed an annualized forfeiture rate of 1.0%
for all options. The Company will record additional expense if the
actual forfeiture rate is lower than estimated, and will record a recovery of
prior expense if the actual forfeiture rate is higher than
estimated.
The weighted average fair value per
share of options granted during the six months ended June 30, 2010 and 2009 was
$3.59 and $2.34, respectively. During the three and six
months ended June 30, 2010 and 2009, stock option compensation expense was
recorded as follows:
|
|
Three Months Ended June 30,
|
|
|
Six Months Ended June 30,
|
|
|
|
2010
|
|
|
2009
|
|
|
2010
|
|
|
2009
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost
of sales
|
|
$ |
19,398 |
|
|
$ |
23,327 |
|
|
$ |
39,498 |
|
|
$ |
50,437 |
|
Selling,
general and administrative expenses
|
|
|
229,739 |
|
|
|
226,432 |
|
|
|
377,632 |
|
|
|
428,405 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
stock option compensation expense
|
|
$ |
249,137 |
|
|
$ |
249,759 |
|
|
$ |
417,130 |
|
|
$ |
478,842 |
|
DERMA
SCIENCES, INC. AND SUBSIDIARIES
Notes to
Condensed Consolidated Financial Statements (Unaudited)
As of June 30, 2010, there was $756,265
of unrecognized compensation cost related to nonvested
service and $119,130 nonvested performance based awards granted
under the plan. These costs are expected to be recognized over the
options’ remaining weighted average vesting period of 1.68 years for the service
and .50 years for the performance based awards.
For the
six months ended June 30, 2010 and 2009, no income tax benefit was recognized
related to stock option activity.
Restricted
Common Stock
The Company has a restricted common
stock plan in which 312,500 shares of common stock are reserved for
issuance.
In May, 2010, 20,000 shares of
restricted common stock were granted under the plan to non-employee members of
the Company’s board of directors and vest one year from date of the
grant. The fair market value at the date of grant, determined by the
quoted market price, was $102,400 or $5.12 per share. For the six
months ended June 30, 2010, $17,067 was recorded in operating expense for these
grants.
In May, 2006, 21,875 shares of
restricted common stock were granted to non-employee members of the Company’s
board of directors and vested three years from the date of the
grant. The fair market value at the date of grant, determined by the
quoted market price, was $145,250 or $6.64 per share. The fair market
value of the grant was recognized as compensation expense over the three-year
service period. For the six months ended June 30, 2009, $18,148 was
recorded in operating expense for these grants.
Shares
Reserved for Future Issuance
At June 30, 2010, the Company had
reserved the following shares of common stock for future issuance:
Convertible
preferred shares (series A – D)
|
|
|
284,844 |
|
Common
stock options available for grant
|
|
|
174,026 |
|
Common
stock options outstanding
|
|
|
1,282,975 |
|
Common
stock warrants outstanding (series H – Q)
|
|
|
1,734,531 |
|
Restricted
common stock available for grant
|
|
|
270,625 |
|
Restricted
common stock grants
|
|
|
20,000 |
|
|
|
|
|
|
Total
common stock shares reserved
|
|
|
3,767,001 |
|
|
The
Company’s comprehensive loss was as
follows:
|
|
|
Three
Months Ended
June 30,
|
|
|
Six
Months Ended
June 30,
|
|
|
|
2010
|
|
|
2009
|
|
|
2010
|
|
|
2009
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
loss as reported
|
|
$ |
(932,855 |
) |
|
$ |
(560,502 |
) |
|
$ |
(1,467,759 |
) |
|
$ |
(1,318,581 |
) |
Other
comprehensive income (loss):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Foreign
currency translation adjustment
|
|
|
(247,940 |
) |
|
|
438,787 |
|
|
|
(71,667 |
) |
|
|
246,202 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive
loss
|
|
$ |
(1,180,795 |
) |
|
$ |
(121,715 |
) |
|
$ |
(1,539,426 |
) |
|
$ |
(1,072,379 |
) |
DERMA
SCIENCES, INC. AND SUBSIDIARIES
Notes to
Condensed Consolidated Financial Statements (Unaudited)
The
Company consists of three operating segments: wound care, wound
closure – specialty securement devices and skin care. Products in the
wound care segment consist of basic and advanced dressings, adhesive strips,
ointments and sprays. Wound closure and specialty securement device
products include wound closure strips, nasal tube fasteners and a variety of
catheter fasteners. The skin care segment consists of antibacterial
skin cleansers, hair and body soaps, lotions and moisturizers.
Products
in all three operating segments are marketed to long-term care facilities,
hospitals, physicians, clinics, home health care agencies and other healthcare
institutions. Basic and advanced wound care products are manufactured
both internally and outsourced, while the manufacture of skin care products is
completely outsourced. Wound closure-specialty securement devices are
significantly manufactured in-house. Internally, the segments are
managed at the gross profit level. The aggregation or allocation of
other costs by segment is not practical.
Segment
sales, gross profit and other related information for 2010 and 2009 are as
follows:
Three Months Ended June 30, 2010
|
|
|
|
|
|
Wound Care
|
|
|
Wound Closure-
Specialty
Securement Devices
|
|
|
Skin Care
|
|
|
Other
|
|
|
Total
Company
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
sales
|
|
$ |
12,693,017 |
|
|
$ |
401,680 |
|
|
$ |
135,409 |
|
|
|
- |
|
|
$ |
13,230,106 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross
profit
|
|
|
3,776,908 |
|
|
|
216,708 |
|
|
|
34,288 |
|
|
|
- |
|
|
|
4,027,904 |
|
Total
expenses
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
$ |
(4,960,759 |
) |
|
|
(4,960,759 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
loss
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
(932,855 |
) |
Three Months Ended June 30, 2009
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
sales
|
|
$ |
10,934,794 |
|
|
$ |
436,690 |
|
|
$ |
191,857 |
|
|
|
- |
|
|
$ |
11,563,341 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross
profit
|
|
|
3,144,448 |
|
|
|
236,713 |
|
|
|
46,606 |
|
|
|
- |
|
|
|
3,427,767 |
|
Total
expenses
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
$ |
(3,988,269 |
) |
|
|
(3,988,269 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
loss
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
(560,502 |
) |
Six Months Ended June 30, 2010
|
|
|
|
|
|
Wound Care
|
|
|
Wound Closure-
Specialty
Securement Devices
|
|
|
Skin Care
|
|
|
Other
|
|
|
Total
Company
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
sales
|
|
$ |
24,940,037 |
|
|
$ |
875,151 |
|
|
$ |
259,299 |
|
|
|
- |
|
|
$ |
26,074,487 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross
profit
|
|
|
7,509,833 |
|
|
|
478,213 |
|
|
|
65,257 |
|
|
|
- |
|
|
|
8,053,303 |
|
Total
expenses
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
$ |
(9,521,062 |
) |
|
|
(9,521,062 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
loss
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
(1,467,759 |
) |
DERMA
SCIENCES, INC. AND SUBSIDIARIES
Notes to
Condensed Consolidated Financial Statements (Unaudited)
Six Months Ended June 30, 2009
|
|
|
|
|
|
Wound Care
|
|
|
Wound Closure-
Specialty
Securement Devices
|
|
|
Skin Care
|
|
|
Other
|
|
|
Total
Company
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
sales
|
|
$ |
20,734,277 |
|
|
$ |
897,762 |
|
|
$ |
363,193 |
|
|
|
- |
|
|
$ |
21,995,232 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross
profit
|
|
|
6,205,071 |
|
|
|
482,737 |
|
|
|
93,594 |
|
|
|
- |
|
|
|
6,781,402 |
|
Total
expenses
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
$ |
(8,099,983 |
) |
|
|
(8,099,983 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
loss
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
(1,318,581 |
) |
The
following table presents net sales by geographic region.
|
|
Three Months Ended
June 30,
|
|
|
Six Months Ended
June 30,
|
|
|
|
2010
|
|
|
2009
|
|
|
2010
|
|
|
2009
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
United
States
|
|
|
67 |
% |
|
|
72 |
% |
|
|
67 |
% |
|
|
73 |
% |
Canada
|
|
|
27 |
% |
|
|
24 |
% |
|
|
28 |
% |
|
|
22 |
% |
Other
|
|
|
6 |
% |
|
|
4 |
% |
|
|
5 |
% |
|
|
5 |
% |
For the six months ended June 30, 2010,
one U.S. customer was responsible for 13% of U.S. sales. The
Company’s wholly owned Canadian subsidiary sells to one customer who serves as
its exclusive third party distributor and comprises 100% of Canada operations
trade accounts receivable at June 30, 2010.
The
Company recorded a $137,652 foreign income tax provision for the six months
ended June 30, 2010 and a $52,388 foreign income tax benefit for the six months
ended June 30, 2009 based on the operating results of the Company’s wholly owned
Canadian subsidiary. The 2010 provision was comprised of $176,644
current foreign tax payable and $38,992 deferred foreign tax benefit while the
2009 benefit was comprised of $29,684 current foreign tax and $22,704 deferred
foreign tax benefits. No benefit was realized for the Company’s net
loss from U.S. operations in the six months ended June 30, 2010 and 2009 due to
uncertainties surrounding the Company’s ability to utilize its net operating
loss carry forwards.
Due to
uncertainties surrounding the Company’s ability to use its U.S. net operating
loss carry forwards and net deferred assets, a full valuation allowance has been
provided. The Company’s wholly owned Canadian subsidiary, based on
recent operating profitability and the prospect of future profitable operations,
realized its net operating loss carry forward and deferred tax assets and
liabilities.
9.
|
Comvita
Licensing, Manufacturing and Sales
Agreement
|
On February 23, 2010, the Company
entered into various agreements with Comvita in which the Company principally
received perpetual and exclusive worldwide licensing rights for Medihoney®
professional wound and skin care products covering distribution and sales to all
markets outside of the consumer market. In connection with the
agreements the Company paid $2,250,000 and issued Comvita 400,000 shares of its
common stock together with 133,333 warrants to purchase its common stock at an
exercise price of $5.50 per share and 100,000 warrants to purchase its common
stock at a price of $6.25 per share. The total consideration paid to
Comvita was valued at $4,509,000. The $4,509,000 cost of the
perpetual and worldwide licensing rights has been recorded as an intangible
asset and will be amortized over an estimated useful life of 10
years.
DERMA
SCIENCES, INC. AND SUBSIDIARIES
Notes to
Condensed Consolidated Financial Statements (Unaudited)
The
agreement calls for royalty payments on all sales and additional payments to
Comvita if certain Medihoney® net sales milestones are achieved over the course
of the license. The license rights may be terminated or rendered non-exclusive
by Comvita if the Company fails to meet certain minimum royalty
requirements.
Item
2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Quarter
Ended June 30, 2010 Compared to Quarter Ended June 30, 2009
Overview
The
following table highlights the quarter ended June 30, 2010 versus 2009 operating
results:
|
|
Quarter Ended June 30,
|
|
|
Variance
|
|
|
|
2010
|
|
|
2009
|
|
|
|
|
|
|
|
Gross
Sales
|
|
$ |
15,813,393 |
|
|
$ |
13,709,673 |
|
|
$ |
2,103,720 |
|
|
|
15.3 |
% |
Sales
adjustments
|
|
|
(2,583,287 |
) |
|
|
(2,146,332 |
) |
|
|
(436,955 |
) |
|
|
20.4 |
% |
Net
sales
|
|
|
13,230,106 |
|
|
|
11,563,341 |
|
|
|
1,666,765 |
|
|
|
14.4 |
% |
Cost
of sales
|
|
|
9,202,202 |
|
|
|
8,135,574 |
|
|
|
1,066,628 |
|
|
|
13.1 |
% |
Gross
profit
|
|
|
4,027,904 |
|
|
|
3,427,767 |
|
|
|
600,137 |
|
|
|
17.5 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling,
general and administrative expense
|
|
|
4,689,774 |
|
|
|
3,703,038 |
|
|
|
986,736 |
|
|
|
26.6 |
% |
Research
and development expense
|
|
|
123,744 |
|
|
|
87,580 |
|
|
|
36,164 |
|
|
|
41.3 |
% |
Interest
expense
|
|
|
134,707 |
|
|
|
239,600 |
|
|
|
(104,893 |
) |
|
|
(43.8 |
)% |
Other
income, net
|
|
|
(68,625 |
) |
|
|
(42,252 |
) |
|
|
(26,373 |
) |
|
|
62.4 |
% |
Total
expenses
|
|
|
4,879,600 |
|
|
|
3,987,966 |
|
|
|
891,634 |
|
|
|
22.4 |
% |
Loss
before income taxes
|
|
|
(851,696 |
) |
|
|
(560,199 |
) |
|
|
(291,497 |
) |
|
|
52.0 |
% |
Provision
for income taxes
|
|
|
81,159 |
|
|
|
303 |
|
|
|
80,856 |
|
|
|
|
|
Net
loss
|
|
$ |
(932,855 |
) |
|
$ |
(560,502 |
) |
|
$ |
(372,353 |
) |
|
|
66.4 |
% |
Gross
to Net Sales Adjustments
Gross to
net sales adjustments comprise the following:
|
|
Quarter Ended June 30,
|
|
|
|
2010
|
|
|
2009
|
|
Gross
Sales
|
|
$ |
15,813,393 |
|
|
$ |
13,709,673 |
|
Trade
rebates
|
|
|
(1,956,035 |
) |
|
|
(1,604,132 |
) |
Distributor
fees
|
|
|
(339,280 |
) |
|
|
(238,459 |
) |
Sales
incentives
|
|
|
(113,163 |
) |
|
|
(130,875 |
) |
Returns
and allowances
|
|
|
(76,308 |
) |
|
|
(80,549 |
) |
Cash
discounts
|
|
|
(98,501 |
) |
|
|
(92,317 |
) |
Total
adjustments
|
|
|
(2,583,287 |
) |
|
|
(2,146,332 |
) |
Net
sales
|
|
$ |
13,230,106 |
|
|
$ |
11,563,341 |
|
Trade
rebates increased in 2010 versus 2009 due principally to higher Canadian sales
subject to rebate, partially offset by the discontinuation of a significant U.S.
private label customer rebate program effective November 1, 2009. The increase
in distribution fee expense is commensurate with the increase in Canadian net
sales upon which it is based. The decrease in sales incentive expense reflects a
reduction in the number of the traditional wound care and first aid products
sales incentive programs in 2010 versus 2009. The slight sales returns and
allowances decrease is principally due to the non-recurrence of higher first aid
products related returns in 2009, partially offset by higher Canadian returns.
The increase in cash discounts reflects higher U.S. sales subject to cash
discount.
Rebate
Reserve Roll Forward
A three
month roll forward of the trade rebate accruals at June 30, 2010 and 2009 is
outlined below:
|
|
Quarter Ended June 30,
|
|
|
|
2010
|
|
|
2009
|
|
Beginning
balance – March 31
|
|
$ |
2,344,157 |
|
|
$ |
2,673,350 |
|
Rebates
paid
|
|
|
(1,914,623 |
) |
|
|
(1,968,178 |
) |
Rebates
accrued
|
|
|
1,956,035 |
|
|
|
1,604,132 |
|
Ending
balance – June 30
|
|
$ |
2,385,569 |
|
|
$ |
2,309,304 |
|
The
$41,412 increase in the trade rebate reserve balance for the three months ended
June 30, 2010 is due to timing. There has been no other discernable change in
the nature of our business in 2010 as it relates to the accrual and subsequent
payment of rebates.
Net
Sales and Gross Margin
The
following table highlights the June 30, 2010 versus 2009 product line net sales
and gross profit:
|
|
Quarter Ended June 30,
|
|
|
Variance
|
|
|
|
2010
|
|
|
2009
|
|
|
|
|
|
|
|
Net
Sales
|
|
$ |
13,230,106 |
|
|
$ |
11,563,341 |
|
|
$ |
1,666,765 |
|
|
|
14.4 |
% |
Cost
of sales
|
|
|
9,202,202 |
|
|
|
8,135,574 |
|
|
|
1,066,628 |
|
|
|
13.1 |
% |
Gross
Profit
|
|
$ |
4,027,904 |
|
|
$ |
3,427,767 |
|
|
$ |
600,137 |
|
|
|
17.5 |
% |
Gross
Profit %
|
|
|
30.4 |
% |
|
|
29.6 |
% |
|
|
|
|
|
|
|
|
Consolidated
net sales increased $1,666,765, or 14.4% (11.4% adjusted for exchange), in 2010
versus 2009. Canadian net sales increased $814,867, or 29.7%, to $3,559,150 in
2010 from $2,744,282 in 2009. This increase was driven by favorable exchange of
$352,827 associated with a 11.9% strengthening of the Canadian dollar, coupled
with sales growth of $462,040. The sales growth reflects the impact of inventory
rationalization on the part of our exclusive Canadian distributor of $603,605,
partially offset by $141,565, or 3.8%, attributable to lower demand. U.S. net
sales increased $555,673, or 6.3%, to $9,374,731 in 2010 from $8,819,058 in
2009. The increase was principally driven by higher advanced wound care sales of
$471,506, or 27.1%, and first aid product sales of $260,112, or 8.4%. The
balance of U.S. sales consisting of traditional wound care, private label,
specialty fixation, burn care and skin care and bathing sales were down 4.4%
quarter to quarter. The higher advanced wound care sales reflect continued
growth of our new products in response to expanded sales and marketing efforts.
The increase in first aid products sales reflects new business and improving
demand. Sales of $296,225 associated with our recently initiated international
growth strategy also contributed.
Consolidated
gross profit increased $600,137, or 17.5%, in 2010 versus 2009. The consolidated
gross profit margin percentage increased to 30.4% in 2010 from 29.6% in 2009.
The change in gross profit dollars reflects the higher sales, together with the
improved gross profit margin percentage. The higher gross margin profit
percentage reflects favorable mix towards higher margined products, partially
offset by increasing product costs and higher obsolescence and transportation
expense.
Selling,
General and Administrative Expenses
The
following table highlights June 30, 2010 versus 2009 selling, general and
administrative expenses by type:
|
|
Quarter Ended June 30,
|
|
|
Variance
|
|
|
|
2010
|
|
|
2009
|
|
|
|
|
|
|
|
Distribution
|
|
$ |
454,010 |
|
|
$ |
459,741 |
|
|
$ |
(5,731 |
) |
|
|
(1.2 |
)% |
Marketing
|
|
|
524,782 |
|
|
|
438,855 |
|
|
|
85,927 |
|
|
|
19.6 |
% |
Sales
|
|
|
1,669,958 |
|
|
|
1,221,821 |
|
|
|
448,137 |
|
|
|
36.7 |
% |
General
and administrative
|
|
|
2,041,024 |
|
|
|
1,582,621 |
|
|
|
458,403 |
|
|
|
29.0 |
% |
Total
|
|
$ |
4,689,774 |
|
|
$ |
3,703,038 |
|
|
$ |
986,736 |
|
|
|
26.6 |
% |
Selling,
general and administrative expenses increased $986,736, or 26.6% (24.6% adjusted
for exchange), in 2010 versus 2009, including an increase of $72,282 in Canadian
selling, general and administrative expenses attributable to
exchange.
Distribution
expense decreased $5,731, or 1.2% (2.8% adjusted for exchange), in 2010 versus
2009, including an increase of $7,329 due to exchange. This decrease
reflects lower labor requirements in the Houston distribution center and lower
utilities due to a warmer average temperature in 2010, partially offset by
higher inflation related compensation and benefit costs and higher U.S. lease
costs.
Marketing
expense increased $85,927, or 19.6% (18.6% adjusted for exchange), in 2010
versus 2009, including an increase of $4,377 due to exchange. The increase is
attributable to higher U.S., Canada and international promotion/literature and
show spending in support of our growth initiatives.
Sales expense increased $448,137, or 36.7% (26.3% adjusted for
exchange), in 2010 versus 2009. Expenses in Canada increased $53,322 (including
a $21,642 increase related to exchange) due to higher compensation and benefit
costs, advanced wound care related consulting expenses and sales volume related
group purchasing organization fees. Expenses in the U. S. increased
$235,517. This increase is principally attributable to incremental expense
associated with the planned expansion of the U.S. sales force from ten to twenty
representatives that was completed by the end of the quarter, partially offset
by lower first aid products compensation and benefits associated with a position
eliminated in the first quarter and not replaced. Incremental international
expenses of $159,298 for compensation and benefits, travel, recruiting and
sample expenses associated with the start up of our international growth
initiative also contributed.
General
and administrative expense increased $458,403, or 29.0% (26.3% adjusted for
exchange), in 2010 versus 2009. Expenses in Canada increased $99,426 (including
a $41,934 increase related to exchange). Net of exchange, expenses were up
$57,492 driven principally by compensation and benefits associated with
inflationary increases and one new position, coupled with higher travel and
information technology (upgrading computer software) expenses. Expenses in the
U. S. increased $307,692. This increase reflects incremental amortization
expense of $114,800 associated with the Worldwide Medihoney License Agreement
signed in February 2010, higher planned investor relations expenses of $68,840
designed to increase investor awareness and improve our stock’s trading volume,
bad debt expense of $45,366, together with higher equity based compensation,
travel and board related expenses. Inflation related increases in professional
services and general operating expenses also contributed. Incremental
international expenses of $51,285 consisting of transition related management,
legal and travel expenses associated with the start up of our international
growth initiative were incurred.
Research
and Development Expense
Research
and development expense increased $36,164 to $123,744 in 2010 from $87,580 in
2009. The increase principally reflects data management expenses that originated
in the second half of 2009.
Interest
Expense
Interest
expense decreased $104,893 to $134,707 in 2010 from $239,600 in 2009. The
decrease is principally attributable to lower term and promissory note interest
associated with the payoff of these loans in February 2010, lower loan related
fees and lower deferred financing expense due to the write-off of a portion of
the outstanding deferred financing balance in connection with the payoff of the
term loan. Line of credit interest was comparable quarter to quarter as the
impact of slightly lower borrowing levels was offset by slightly higher interest
rates.
Other
Income
Other
income increased $26,373 to $68,625 in 2010 from $42,252 in 2009. The main
driver for the net quarter to quarter increase was an exchange gain of $26,896
and slightly higher royalty income, partially offset by higher miscellaneous
expense.
Income
Taxes
We
recorded a $81,159 foreign income tax provision for 2010 consisting of a $90,125
current foreign tax provision and a $8,966 deferred foreign tax benefit based on
our Canadian subsidiary’s operating results. No tax benefit was recorded for our
U.S. operations in 2010 or 2009 due to uncertainty surrounding our ability to
use available net operating loss carry forwards and net deferred tax
assets. In 2009, we recorded a $303 foreign income tax provision
consisting of a $8,872 current foreign tax provision and a $8,569 deferred
foreign tax benefit based on our Canadian subsidiary’s operating
results.
Due to
uncertainties surrounding our ability to use our U.S. net operating loss carry
forwards and net deferred tax assets, a full valuation allowance for the U.S.
net deferred tax assets has been provided.
Net
Loss
We
generated a net loss of $932,855, or $0.14 per share (basic and diluted), in
2010 compared to a net loss of $560,502, or $0.11 per share (basic and diluted),
in 2009.
Six
Months Ended June 30, 2010 Compared to Six Months Ended June 30,
2009
Overview
The
following table highlights the six months ended June 30, 2010 versus 2009
operating results:
|
|
Six
Months Ended June 30,
|
|
|
Variance
|
|
|
|
2010
|
|
|
2009
|
|
|
|
|
|
|
|
Gross
Sales
|
|
$ |
31,264,529 |
|
|
$ |
26,311,433 |
|
|
$ |
4,953,096 |
|
|
|
18.8 |
% |
Sales
adjustments
|
|
|
(5,190,042 |
) |
|
|
(4,316,201 |
) |
|
|
(873,841 |
) |
|
|
20.2 |
% |
Net
sales
|
|
|
26,074,487 |
|
|
|
21,995,232 |
|
|
|
4,079,255 |
|
|
|
18.6 |
% |
Cost
of sales
|
|
|
18,021,184 |
|
|
|
15,213,830 |
|
|
|
2,807,354 |
|
|
|
18.5 |
% |
Gross
profit
|
|
|
8,053,303 |
|
|
|
6,781,402 |
|
|
|
1,271,901 |
|
|
|
18.8 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling,
general and administrative expense
|
|
|
8,913,019 |
|
|
|
7,567,164 |
|
|
|
1,345,855 |
|
|
|
17.8 |
% |
Research
and development expense
|
|
|
239,851 |
|
|
|
217,926 |
|
|
|
21,925 |
|
|
|
10.1 |
% |
Interest
expense
|
|
|
294,599 |
|
|
|
411,070 |
|
|
|
(116,471 |
) |
|
|
(28.3 |
)% |
Loss
on debt extinguishment
|
|
|
114,072 |
|
|
|
- |
|
|
|
114,072 |
|
|
|
|
|
Other
income, net
|
|
|
(178,131 |
) |
|
|
(43,789 |
) |
|
|
(134,342 |
) |
|
|
306.8 |
% |
Total
expenses
|
|
|
9,383,410 |
|
|
|
8,152,371 |
|
|
|
1,231,039 |
|
|
|
15.1 |
% |
Loss
before income taxes
|
|
|
(1,330,107 |
) |
|
|
(1,370,969 |
) |
|
|
40,862 |
|
|
|
|
|
Provision
(benefit) for income taxes
|
|
|
137,652 |
|
|
|
(52,388 |
) |
|
|
(190,040 |
) |
|
|
|
|
Net
loss
|
|
$ |
(1,467,759 |
) |
|
$ |
(1,318,581 |
) |
|
$ |
(149,178 |
) |
|
|
11.3 |
% |
Gross
to Net Sales Adjustments
Gross to
net sales adjustments comprise the following:
|
|
Six Months Ended June 30,
|
|
|
|
2010
|
|
|
2009
|
|
Gross
Sales
|
|
$ |
31,264,529 |
|
|
$ |
26,311,433 |
|
Trade
rebates
|
|
|
(3,903,902 |
) |
|
|
(3,113,426 |
) |
Distributor
fees
|
|
|
(668,952 |
) |
|
|
(445,197 |
) |
Sales
incentives
|
|
|
(236,973 |
) |
|
|
(288,700 |
) |
Returns
and allowances
|
|
|
(173,462 |
) |
|
|
(266,048 |
) |
Cash
discounts
|
|
|
(206,753 |
) |
|
|
(202,830 |
) |
Total
adjustments
|
|
|
(5,190,042 |
) |
|
|
(4,316,201 |
) |
Net
sales
|
|
$ |
26,074,487 |
|
|
$ |
21,995,232 |
|
Trade
rebates increased in 2010 versus 2009 due principally to higher Canadian sales
subject to rebate, partially offset by the discontinuation of a significant U.S.
private label customer rebate program effective November 1, 2009. The increase
in distribution fee expense is commensurate with the increase in Canadian net
sales upon which it is based. The decrease in sales incentive expense reflects a
reduction in the number of the traditional wound care and first aid products
sales incentive programs in 2010 versus 2009. The sales returns and allowances
decrease is principally due to the non-recurrence of higher first aid products
related returns in 2009, partially offset by higher Canadian returns. The
increase in cash discounts reflects higher U.S. sales subject to cash
discount.
Rebate
Reserve Roll Forward
A six
month roll forward of the trade rebate accruals at June 30, 2010 and 2009 is
outlined below:
|
|
Six Months Ended June 30,
|
|
|
|
2010
|
|
|
2009
|
|
Beginning
balance – January 1
|
|
$ |
2,493,232 |
|
|
$ |
2,660,086 |
|
Rebates
paid
|
|
|
(4,011,565 |
) |
|
|
(3,464,208 |
) |
Rebates
accrued
|
|
|
3,903,902 |
|
|
|
3,113,426 |
|
Ending
balance – June 30
|
|
$ |
2,385,569 |
|
|
$ |
2,309,304 |
|
The
$107,663 decrease in the trade rebate reserve balance for the six months ended
June 30, 2010 reflects the decision of one significant U.S. private label
customer to discontinue its rebate program effective November 1, 2009 and the
subsequent payment of the outstanding balance due this customer in 2010,
partially offset by an increase in the Canadian reserve due to higher sales.
There has been no other discernable change in the nature of our business in 2010
as it relates to the accrual and subsequent payment of rebates.
Net
Sales and Gross Margin
The
following table highlights the June 30, 2010 versus 2009 product line net sales
and gross profit:
|
|
Six Months Ended June 30,
|
|
|
Variance
|
|
|
|
2010
|
|
|
2009
|
|
|
|
|
|
|
|
Net
Sales
|
|
$ |
26,074,487 |
|
|
$ |
21,995,232 |
|
|
$ |
4,079,255 |
|
|
|
18.6 |
% |
Cost
of sales
|
|
|
18,021,184 |
|
|
|
15,213,830 |
|
|
|
2,807,354 |
|
|
|
18.5 |
% |
Gross
Profit
|
|
$ |
8,053,303 |
|
|
$ |
6,781,402 |
|
|
$ |
1,271,901 |
|
|
|
18.8 |
% |
Gross
Profit %
|
|
|
30.9 |
% |
|
|
30.8 |
% |
|
|
|
|
|
|
|
|
Consolidated
net sales increased $4,079,255, or 18.6% (15.0% adjusted for exchange), in 2010
versus 2009. Canadian net sales increased $2,160,238, or 43.6%, to $7,109,925 in
2010 from $4,949,687 in 2009. This increase was driven by favorable exchange of
$783,369 associated with a 14.2% strengthening of the Canadian dollar, coupled
with sales growth of $1,376,869. The sales growth reflects the impact of
inventory rationalization on the part of our exclusive Canadian distributor of
$1,406,566, partially offset by $29,697 attributable to lower demand. U.S. net
sales increased $1,502,070, or 8.8%, to $18,547,615 in 2010 from $17,045,545 in
2009. The increase was principally driven by higher advanced wound care sales of
$1,198,603, or 39.1%, and first aid product sales of $479,196, or 7.9%. The
balance of U.S. sales consisting of traditional wound care, private label,
specialty fixation, burn care and skin care and bathing sales were down 2.2%
period to period. The higher advanced wound care sales reflect continued growth
of our new products in response to expanded sales and marketing efforts. The
increase in first aid products sales reflects new business and improving demand.
Sales of $416,947 associated with our recently initiated international growth
strategy also contributed.
Consolidated
gross profit increased $1,271,901, or 18.8%, in 2010 versus 2009. The
consolidated gross profit margin percentage increased slightly to 30.9% in 2010
from 30.8% in 2009. The change in gross profit dollars reflects the higher
sales. While comparable period to period, the slight improvement in gross profit
percentage reflects a favorable sales mix towards higher margined products,
offset by increasing products costs and higher obsolescence and transportation
expense.
Selling,
General and Administrative Expenses
The
following table highlights June 30, 2010 versus 2009 selling, general and
administrative expenses by type:
|
|
Six Months Ended June 30,
|
|
|
Variance
|
|
|
|
2010
|
|
|
2009
|
|
|
|
|
|
|
|
Distribution
|
|
$ |
905,437 |
|
|
$ |
887,474 |
|
|
$ |
17,963 |
|
|
|
2.0 |
% |
Marketing
|
|
|
852,864 |
|
|
|
829,787 |
|
|
|
23,077 |
|
|
|
2.8 |
% |
Sales
|
|
|
3,128,385 |
|
|
|
2,436,862 |
|
|
|
691,523 |
|
|
|
28.4 |
% |
General
and administrative
|
|
|
4,026,333 |
|
|
|
3,413,041 |
|
|
|
613,292 |
|
|
|
18.0 |
% |
Total
|
|
$ |
8,913,019 |
|
|
$ |
7,567,164 |
|
|
$ |
1,345,855 |
|
|
|
17.8 |
% |
Selling,
general and administrative expenses increased $1,345,855, or 17.8% (15.2%
adjusted for exchange), in 2010 versus 2009, including an increase of $197,455
in Canadian selling, general and administrative expenses attributable to
exchange.
Distribution
expense increased $17,963, or 2.0%, in 2010 versus 2009 due to exchange.
Excluding exchange, distribution expenses decreased $408. This slight decrease
reflects lower labor requirements in the Houston distribution center and lower
utilities due to a warmer average temperature in 2010, partially offset by
higher inflation related compensation and benefit, lease and operating
expenses.
Marketing
expense increased $23,077, or 2.8% (1.5% adjusted for exchange), in 2010 versus
2009, including an increase of $10,693 due to exchange. The increase is
attributable to higher U.S., Canada and international promotion/literature and
show spending in support of our growth initiatives, partially offset by lower
sampling expense in Canada and product development related consulting expense in
the U.S..
Sales
expense increased $691,523, or 28.4% (26.3% adjusted for exchange), in 2010
versus 2009. Expenses in Canada increased $93,348 (including a $50,442 increase
related to exchange) due to higher compensation and benefit costs, advanced
wound care related consulting expenses, sales volume related group purchasing
organization and travel expenses. Expenses in the U. S. increased
$396,378. This increase is attributable to incremental costs of approximately
$342,000 consisting of compensation and benefits, travel and recruiting expenses
associated with the expansion of the advanced wound care sales force from ten to
twenty representatives that was completed in June 2010 and approximately
$124,000 of first aid products severance expense associated with the termination
of an executive in the first quarter 2010, partially offset by lower
administrative related operating expenses. Also contributing were incremental
international expenses of $201,797 consisting of compensation and benefits,
travel, recruiting and sample expenses associated with the start up of our
international growth initiative.
General
and administrative expense increased $613,292, or 18.0% (14.5% adjusted for
exchange), in 2010 versus 2009. Expenses in Canada increased $172,388 (including
a $117,950 increase related to exchange). Net of exchange, expenses were up
$54,438 driven principally by compensation and benefits associated with
inflationary increases and one new position, coupled with higher travel and
information technology expenses. Expenses in the U.S. increased $347,671. This
increase reflects incremental amortization expense of $148,587 associated with
the Worldwide Medihoney License Agreement signed in February 2010, higher
planned investor relations expenses of $104,258 designed to increase investor
awareness and improve our stock’s trading volume, bad debt expense of $67,354,
together with slightly higher overall operating expenses. Incremental
international expenses of $93,233 consisting principally of transition related
management, legal and travel expenses associated with the start up of our
international growth initiative also contributed.
Research
and Development Expense
Research
and development expense increased $21,925 to $239,851 in 2010 from $217,926 in
2009. The increase principally reflects higher data management expense that
started in the second half of 2009, less lower patent related legal
expenses.
Interest
Expense
Interest
expense decreased $116,471 to $294,599 in 2010 from $411,070 in 2009. The
decrease is principally attributable to lower term and promissory note interest
associated with the payoff of these loans in February 2010, lower loan related
fees and lower deferred financing expense due to the write-off of a portion of
the outstanding deferred financing balance in connection with the payoff of the
term loan. These decreases were partially offset by higher line of credit
interest principally attributable to higher interest rates.
Loss
on Extinguishment of Debt
In
connection with the payoff of our term loan in February 2010, we took a charge
of $114,072 representing that portion of the unamortized deferred financing
costs relating to the term loan.
Other
Income
Other
income increased $134,342 to $178,131 in 2010 from $43,789 in 2009. The main
drivers for the net period to period increase was an exchange gain of $199,450
(2010 income of $162,910 versus a 2009 loss of $36,540), partially offset by the
non-recurrence of approximately $60,000 of gains on miscellaneous asset sales
principally associated with the closure of the first aid product manufacturing
operation.
Income
Taxes
We
recorded a $137,652 foreign income tax provision for 2010 consisting of a
$176,644 current foreign tax provision and a $38,992 deferred foreign tax
benefit based on our Canadian subsidiary’s operating results. No tax benefit was
recorded for our U.S. operations in 2010 or 2009 due to uncertainty surrounding
our ability to use available net operating loss carry forwards and net deferred
tax assets. In 2009, we recorded a $52,388 foreign income tax benefit
consisting of a $29,684 current tax benefit and a $22,704 deferred foreign tax
benefit based on our Canadian subsidiary’s operating results.
Due to
uncertainties surrounding our ability to use our U.S. net operating loss carry
forwards and net deferred tax assets, a full valuation allowance for the U.S.
net deferred tax assets has been provided.
Net
Loss
We
generated a net loss of $1,467,759, or $0.24 per share (basic and diluted), in
2010 compared to a net loss of $1,318,581, or $0.26 per share (basic and
diluted), in 2009.
Liquidity and Capital
Resources
Cash
Flow and Working Capital
At
June 30, 2010 and December 31, 2009, we had cash and cash equivalents of
$385,424 and $243,524, respectively. The $141,900 increase in cash reflects net
cash provided by financing activities of $4,282,586, partially offset by cash
used in investing activities of $2,389,236 and operating activities of
$1,750,140, together with cash used as a result of exchange rate changes of
$1,310.
Net cash
used in operating activities of $1,750,140 stems from $642,460
cash provided from operations (net loss plus non-cash items), together with
$2,392,600
cash used from the net change in operating assets and liabilities. The increase
in cash provided from operations reflects the non-cash items, partially offset
by the operating loss. Higher receivables and inventory, offset by accounts
payable and accrued liabilities, were the main drivers behind the net cash used
in connection with the change in operating assets and liabilities. The increase
in receivables reflects a higher level of sales in June, addition of receivables
related to the international business and the final payoff of rebates owed in
connection with the discontinuation of a significant rebate program. The
increase in inventory reflects a build up to support new products, addition of
the international business and to improve customer service levels in certain
segments of our business. The increase in accounts payable reflects an increase
in payables related to inventory purchases, addition of the international
business and higher overall spending levels. The increase in accrued expenses
and other current liabilities principally reflects higher Canadian rebates due
to higher sales, accrued foreign taxes payable and the recording of a severance
accrual.
Net cash
used in investing activities of $2,389,236 reflects $2,250,000 cash used to
purchase the worldwide Medihoney license rights and capital expenditures of
$139,236.
Net cash
used in financing activities of $4,282,586 reflects net proceeds of $4,491,279
from the sale of stock in connection with a secondary public offering completed
in February and the exercise of stock options, removal of the restriction on the
use of $2,032,164 in cash and $1,801,170 from an increase in the amount drawn
against our line of credit. Offsetting these increases were $4,042,027 in debt
payments consisting of regularly scheduled debt repayments, together with the
full payment of the balances of our term loan and our promissory
note.
Working
capital increased $2,473,301 at June 30, 2010 to $9,264,882 from $6,791,581 at
December 31, 2009. This increase principally reflects the cash infusion
associated with the equity raise completed in February, a portion of the
proceeds of which were used to pay off short term debt of $1,700,000, and the
net balance of $461,619 that was used for general working capital purposes.
Working capital of this magnitude is considered sufficient to support ongoing
operations.
Based on
current forecasts, there are no Medihoney sales related milestone payments
anticipated in the next twelve months.
Financing
Arrangements
With cash
on hand of $385,424, together with available cash under our line of credit of
$2,125,247, we had $2,510,671 of available liquidity at June 30, 2009, versus
$2,342,579 at December 31, 2009.
On
February 22, 2010, we raised $4,478,801 (net of commission and other offering
expenses) from the sale in a secondary public offering of shares of our common
stock. These proceeds, together with $2,032,818 of previously restricted cash,
were used to acquire the worldwide Medihoney licensing rights for $2,250,000,
pay off the outstanding U.S. term loan of $3,300,000 and pay off our $500,000
promissory note due April 14, 2010, leaving $461,619 of the net proceeds
available for general working capital purposes. Payment of the foregoing
indebtedness has had a positive impact on cash flow by eliminating associated
debt service.
On March
26, 2010, our U.S. lender modified the terms of our five year revolving credit
and security agreement to take into account the payment of the term
loan. The existing financial covenants were replaced with twelve
month rolling fixed charge coverage and total debt coverage covenants. The
lender also reduced the minimum 3 month LIBOR rate from 3.00% to 1.50% and
authorized the payment of our $500,000 unsecured promissory note, which was paid
on March 31, 2010. In addition, the minimum excess availability reserve was
reduced from $1,500,000 to $1,000,000, thereby increasing our borrowing
availability by $500,000 upon satisfactory completion of the lenders’ latest
field exam in May 2010.
Prospective
Assessment
Our
strategic objective is to in-license, develop and launch novel higher margined
advanced wound care products while utilizing our core business (to the extent
possible) to fund this objective. In addition, we will continue to evaluate
external opportunities to leverage our core capabilities for growth. To the
extent we determine that we cannot finance our growth initiatives internally, we
will evaluate the feasibility of doing so via the sale of equity.
The
launch of a number of new products in recent years bodes well for the future
growth of our higher-margined advanced wound care products both domestically and
abroad. We continue to work on our pipeline and have identified several product
line extensions for existing products and new products that are capable of
contributing to future sales growth. We believe that the first aid products line
continues to represent a solid growth opportunity. Sales for the balance of our
product lines are expected to remain relatively stable.
Our
strategy for growth is:
|
1.
|
Assuming the existing resources
in place are generating the expected return, we will continue to expand
our investment in sales and marketing resources in support of our advanced
wound care products in the U.S. Starting with ten sales representatives at
the beginning of the year, we presently have twenty direct sales
representatives in place.
|
|
2.
|
The first aid products business
represents a growth opportunity. In addition to its core business
opportunities, the first aid products business will serve as a platform
for introducing our existing advanced and traditional wound care products
to new customers and markets, especially the retail market. We continue to
work on completion of a cost effective supply chain for first aid
products. The supply chain is expected to be fully operational within the
next six months, at which time we expect to be able to improve liquidity
by reducing the level of inventory required to support the
business.
|
|
3.
|
In February 2010, we licensed the
worldwide rights to Medihoney. This will serve as the catalyst for the
expansion of our international business. Plans are in place to establish a
direct presence in Europe immediately and, ultimately, in other areas of
the world employing a direct presence or distributor model as the basis
for conducting business, as circumstances
dictate.
|
|
4.
|
We made a significant investment in DSC 127 beginning in
December 2007. While the launch of DSC 127 is several years away, we
believe the market potential for this product is considerable. The product
began Phase II trials in early 2008 to achieve proof of principle in a
human model. The projected cost to complete the Phase II trial is
approximately $1,750,000, including $1,292,735 incurred through June 2010.
We plan to continue with this investment and anticipate spending
approximately $457,265 to complete the Phase II trial. We
expect to announce top-line efficiency data by the end of the year and
complete the study in the first quarter of
2011.
|
The
results of the Phase II trial will determine the efficacy and safety of the
product and further refine its market potential. The cost of the Phase III trial
and bringing the product to market are expected to be significant. Should we
decide to proceed with the DSC 127 development plan after completion of Phase
II, we plan to fund the additional development costs via a joint venture, out of
available cash flow or the sale of equity. Alternatively, we may determine to
sublicense or sell the rights to the compound.
With the
planned improvement in operations and expected working capital requirements,
together with the available cash on hand and available borrowing capacity as of
June 30, 2010, we anticipate having sufficient liquidity in place to meet our
operating needs and debt covenants for the foreseeable future.
Our
common stock is traded on the NASDAQ Capital Market under the symbol “DSCI.” We
have paid no cash dividends in respect of our common stock and do not intend to
pay cash dividends in the near future.
Additional Financial
Information
Forward
Looking Statements
Statements
that are not historical facts, including statements about our confidence,
strategies, expectations about new or existing products, technologies,
opportunities, market demand or acceptance of new or existing products are
forward-looking statements that involve risks and
uncertainties. These uncertainties include, but are not limited to,
product demand and market acceptance risk, impact of competitive products and
prices, product development, commercialization or technological delays or
difficulties, and trade, legal, social, financial and economic
risks.
Critical
Accounting Policies
Estimates
and assumptions are required in the determination of sales deductions for trade
rebates, sales incentives, discounts and allowances. Significant estimates and
assumptions are also required in determining the appropriateness of amortization
periods for identifiable intangible assets, the potential impairment of goodwill
and the valuation of inventory. Some of these judgments can be subjective and
complex and, consequently, actual results may differ from these estimates. For
any individual estimate or assumption made by us, there may also be other
reasonable estimates or assumptions. We believe, however, that given current
facts and circumstances, it is unlikely that applying any such other reasonable
judgment would cause a material adverse effect on the consolidated results of
operations, financial position or cash flows for the periods presented. Our most
critical accounting policies are described below.
Revenue
Recognition and Adjustments to Revenue
We sell
our products through our own direct sales force and through independent
distributors and manufacturers’ representatives. The primary end users of our
products are nursing homes, hospitals, clinics and home healthcare agencies. We
recognize revenue from the sale of our products when persuasive evidence of an
arrangement exists, delivery has occurred, the sales price is fixed and
determinable, and collectability is reasonably assured, which is generally at
the time of shipment or receipt by our customers, depending on the terms of the
related sales or distribution agreement. When we recognize revenue from the sale
of our products, we simultaneously adjust revenue for estimated trade rebates
and distribution fees (in Canada), and estimates of returns and allowances, cash
discounts and other sales incentives.
A trade
rebate represents the difference between the invoice price to the
wholesaler/distributor and the end user’s contract price. These rebates are
estimated monthly based on historical experience, distributor rebate submission
trends, estimated distributor inventory levels, and existing contract sales
terms with our distributors and end users. We have a contract with our exclusive
Canadian distributor and we pay a fixed fee based on sales subject to the fee
(as defined) for distribution services in Canada. Because the services performed
by the distributor cannot be separated from the purchase of our products by the
distributor, we treat this distribution fee as a reduction of revenue. The
distribution fee is accrued monthly based on net sales to the distributor
multiplied by the ratio of recent historical distributor fee expense to net
sales. The percentage of distributor fee expense to net sales is re-evaluated
quarterly for reasonableness.
Sales
incentives represent credits granted to specific customers based on attainment
of pre-determined sales objectives. Sales incentives are accrued monthly in
accordance with the terms of the underlying sales incentive agreement and actual
customer sales. Sales incentive agreements are generally for a period of one
year.
We
provide our customers certain limited return rights and we have a formal
returned goods policy that guides the disposition of returns with our customers.
We accrue for sales returns and allowances and cash discounts monthly based on
current sales and historical activity. We do not offer our customers price
protection rights or concessions. Returns have historically represented less
than 1% of gross sales.
We
continually monitor the factors that influence rebates and fees, returns and
allowances, and other discounts and sales incentives and make adjustments as
necessary.
Goodwill
At June
30, 2010, we had $7,119,726 of goodwill consisting of $4,679,684 relating to the
First Aid Products acquisition in November 2007 and $2,440,042 relating to the
Western Medical acquisition in April 2006. We assess the impairment of goodwill
annually in the fourth quarter or whenever events or changes in circumstances
indicate that the carrying value of goodwill may not be recoverable. The
assessment is performed using the two-step process required by FASB accounting
guidance relating to goodwill. The first step is a review for potential
impairment, while the second step measures the amount of the impairment, if any.
The first step of the goodwill impairment test compares the fair value of a
reporting unit with its carrying amount, including goodwill. For 2009 and 2008,
the first step of our goodwill impairment test reflected a fair value in excess
of the carrying value of our reporting units. Accordingly, we did not perform
the second step of this test during these periods.
The cash
generating unit level or reporting unit at which we test goodwill for impairment
is the operating segment level as that term is used in FASB accounting guidance
relating to segment reporting. We have three operating segments: wound care,
wound closure – specialty securement devices and skin care. Products are
allocated to each segment based on the nature and intended use of the product.
All of our goodwill has been allocated to the wound care segment as the business
acquisitions which gave rise to the goodwill were wound care
businesses.
For 2009
and 2008 and consistent with prior periods, we estimated the fair value of our
wound care segment using the “income approach” where we use a discounted cash
flow model (“DCF”) in preparing our goodwill impairment
assessment. This approach calculates fair value by estimating the
after-tax cash flows attributable to a reporting unit and then discounting these
after-tax cash flows to a present value using a risk-adjusted discount
rate. We selected this method as being the most meaningful in
preparing our goodwill assessments because we believe the income approach most
appropriately measures our income producing assets.
Significant
estimates used in the fair value calculation include: (i) estimates of future
revenue and expense growth, (ii) future estimated effective tax rates, (iii)
future estimated capital expenditures, (iv) future required investments in
working capital, (v) average cost of capital, and (vi) the terminal value of the
reporting unit.
The
amount and timing of future cash flows within our DCF analysis is based on our
five year forecast. Beyond our five year forecast we assumed a
terminal value to calculate the value of cash flows beyond the last projected
period in our DCF analysis. Annual revenue growth rates in our DCF
model reflect expected growth in our advanced wound care products as well as
growth in the products which we gained access to when we acquired First Aid
Products in November of 2007 as we introduce these products across our existing
customer base. The weighted average cost of capital used to discount
cash flows for the annual 2009 goodwill impairment test was estimated to be
17%.
Over
time, our wound care segment has become an increasingly significant portion of
our overall business. For the year ended December 31, 2009, our wound care
segment accounted for approximately 95% of our consolidated revenue. Given the
significance of this segment to our overall results, we also look to our
publicly traded market value, which we may adjust in consideration of an
appropriate control premium, as an indicator of the fair value of our wound care
segment and the reasonableness of our DCF model.
There
have been no substantial changes to the methodology employed, significant
assumptions or calculations applied in the first step of the goodwill impairment
test over the past several years.
Inventory
We write
down the value of inventory by the estimate of the difference between the cost
of the inventory and its net realizable value. The estimate takes
into account projected sales of the inventory on hand and the age of the
inventory in stock. If actual future demand or market conditions are
less favorable than those projected by management, additional inventory
write-downs may be required. The provision for the write-down of
inventory is recorded in cost of sales.
Stock-Based
Compensation
We record compensation expense
associated with stock options and other equity-based compensation based on their
fair value at the grant date and recognized over the requisite service
periods. We estimate the fair value of stock options as of the date
of grant using the Black-Scholes for service and performance based awards or
binomial/lattice pricing model for market based awards and restricted stock
based on the quoted market price. Significant judgment and the use of
estimates to value the equity-based compensation, particularly surrounding
Black-Scholes or binomial/lattice pricing model assumptions such as stock price
volatility and expected option lives, as well as expected option forfeiture
rates, are made by the Company.
The Company’s management, with the
participation of the Company’s Chief Executive Officer and Chief Financial
Officer, has evaluated the effectiveness of the Company’s disclosure controls
and procedures as of June 30, 2010. Based on this evaluation, the
Company’s Chief Executive Officer and Chief Financial Officer concluded that the
Company’s disclosure controls and procedures are effective for gathering,
analyzing and disclosing the information the Company is required to disclose in
the reports it files under the Securities Exchange Act of 1934, within the time
periods specified in the SEC’s rules and forms.
During the six months ended June 30,
2010, there was no change in the Company’s internal controls over financial
reporting that materially affected, or is reasonably likely to materially
affect, the Company’s internal controls over financial
reporting.
PART
II – OTHER INFORMATION
Item
1A. Risk Factors
The following risk factors update the
related risk factors set forth in the Company’s annual report on Form 10-K filed
with the Securities and Exchange Commission:
We
have a history of losses and can offer no assurance of future
profitability.
We
incurred losses of $1,467,759 for the six months ended June 30, 2010
(unaudited), $1,143,272 in 2009, $3,961,937 in 2008, $2,284,605 in 2007,
$1,099,990 in 2005 and $2,338,693 in 2004. At June 30, 2010, we had an
accumulated deficit of $22,274,854 (unaudited). We cannot offer any assurance
that we will be able to generate sustained or significant future
earnings.
The
potential increase in common shares due to the conversion, exercise or vesting
of outstanding dilutive securities may have a depressive effect upon the market
value of our shares.
Up to
3,322,350 shares of our common stock are potentially issuable upon the
conversion, exercise or vesting of outstanding convertible preferred stock,
warrants and options (“dilutive securities”). The shares of common stock
potentially issuable upon conversion, exercise or vesting of dilutive securities
are substantial compared to the 6,561,826 shares of common stock currently
outstanding.
Earnings
per share of common stock may be substantially diluted by the existence of these
dilutive securities regardless of whether they are converted, exercised or
issued. This dilution of earnings per share could have a depressive effect upon
the market value of our common stock.
Our
stock price has been volatile and this volatility is likely to
continue.
Historically,
the market price of our common stock has been volatile. The high and low stock
prices for the years 2005 through 2009 and the first six months of 2010 are set
forth in the table below:
Derma
Sciences, Inc.
Trading
Range – Common Stock
Year
|
|
Low
|
|
|
High
|
|
2005
|
|
$ |
3.36 |
|
|
$ |
6.24 |
|
2006
|
|
$ |
3.60 |
|
|
$ |
7.20 |
|
2007
|
|
$ |
4.64 |
|
|
$ |
11.20 |
|
2008
|
|
$ |
1.60 |
|
|
$ |
10.80 |
|
2009
|
|
$ |
1.92 |
|
|
$ |
6.80 |
|
2010
*
|
|
$ |
4.67 |
|
|
$ |
9.00
|
|
(*)
January 1 through June 30.
Events
that may affect our common stock price include:
|
•
|
Quarter to quarter variations in
our operating results;
|
|
•
|
Changes in earnings estimates by
securities analysts;
|
|
•
|
Changes in interest rates or
other general economic
conditions;
|
|
•
|
Changes in market conditions in
the wound care industry;
|
|
•
|
Fluctuations in stock market
prices and trading volumes of similar
companies;
|
|
•
|
Discussion
of us or our stock price by the financial and scientific press and in
online investor communities;
|
|
•
|
Additions or departures of key
personnel;
|
|
•
|
Changes in third party
reimbursement policies;
|
|
•
|
The introduction of new products
either by us or by our competitors;
and
|
|
•
|
The loss of a major
customer.
|
Although
all publicly traded securities are subject to price and volume fluctuations, it
is likely that our common stock will experience these fluctuations to a greater
degree than the securities of more established and better capitalized
organizations.
Item
6. Exhibits
All
exhibits required by Item 601 of Regulation S-K and required hereunder, as filed
with the Securities and Exchange Commission in Form 10-K on March 31, 2010, are
incorporated herein by reference.
Exhibit
|
|
Description
|
|
|
|
31.1
|
|
Certification
of the Principal Executive Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
|
31.2
|
|
Certification
of the Principal Financial Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
|
32.1
|
|
Certification
of the Principal Executive Officer pursuant to U.S.C. Section 1350 as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002
|
32.2
|
|
Certification
of the Principal Financial Officer pursuant to U.S.C. Section 1350 as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002
|
Pursuant to the requirements of the
Securities Exchange Act of 1934, the registrant has caused this report to be
signed on its behalf by the undersigned thereunto duly authorized.
|
DERMA
SCIENCES, INC.
|
|
|
|
Dated: August
12, 2010
|
By:
|
/s/ John E.
Yetter
|
|
|
John
E. Yetter, CPA
|
|
|
Chief
Financial Officer
|