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
September 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
o
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:
November 11, 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
|
|
|
|
|
|
Item
1. Financial Statements
|
|
|
|
|
|
Condensed
Consolidated Balance Sheets – September 30, 2010 (Unaudited) and December
31, 2009
|
|
3
|
|
|
|
Condensed
Consolidated Statements of Operations – Three months ended September 30,
2010 and September 30, 2009 (Unaudited)
|
|
4
|
|
|
|
Condensed
Consolidated Statements of Operations – Nine months ended September 30,
2010 and September 30, 2009 (Unaudited)
|
|
5
|
|
|
|
Condensed
Consolidated Statements of Cash Flows – Nine months ended September 30,
2010 and September 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
|
|
17
|
|
|
|
Item
4. Controls and Procedures
|
|
30
|
|
|
|
Part
II - Other Information
|
|
|
|
|
|
Item
1A. Risk Factors
|
|
31
|
|
|
|
Item
6. Exhibits
|
|
32
|
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
|
|
September
30,
2010
(Unaudited)
|
|
|
December
31, 2009
|
|
ASSETS
|
|
|
|
|
|
|
Current
Assets
|
|
|
|
|
|
|
Cash
and cash equivalents
|
|
$ |
409,505 |
|
|
$ |
243,524 |
|
Accounts
receivable, net
|
|
|
5,361,264 |
|
|
|
3,372,712 |
|
Inventories
|
|
|
13,579,298 |
|
|
|
11,489,724 |
|
Prepaid
expenses and other current assets
|
|
|
456,337 |
|
|
|
456,675 |
|
Total
current assets
|
|
|
19,806,404 |
|
|
|
15,562,635 |
|
Cash
– restricted
|
|
|
- |
|
|
|
2,032,164 |
|
Equipment
and improvements, net
|
|
|
3,412,650 |
|
|
|
3,741,347 |
|
Goodwill
|
|
|
7,119,726 |
|
|
|
7,119,726 |
|
Other
intangible assets, net
|
|
|
7,254,725 |
|
|
|
3,994,250 |
|
Other
assets, net
|
|
|
341,110 |
|
|
|
849,753 |
|
Total
Assets
|
|
$ |
37,934,615 |
|
|
$ |
33,299,875 |
|
LIABILITIES
AND SHAREHOLDERS’ EQUITY
|
|
|
|
|
|
|
|
|
Current
Liabilities
|
|
|
|
|
|
|
|
|
Line
of credit borrowings
|
|
|
3,658,625 |
|
|
|
2,306,306 |
|
Current
maturities of long-term debt
|
|
|
14,503 |
|
|
|
1,759,185 |
|
Accounts
payable
|
|
|
4,240,277 |
|
|
|
3,363,096 |
|
Accrued
expenses and other current liabilities
|
|
|
2,305,193 |
|
|
|
1,342,467 |
|
Total
current liabilities
|
|
|
10,218,598 |
|
|
|
8,771,054 |
|
Long-term
debt
|
|
|
- |
|
|
|
2,305,851 |
|
Other
long-term liabilities
|
|
|
69,671 |
|
|
|
96,564 |
|
Deferred
tax liability
|
|
|
321,323 |
|
|
|
355,349 |
|
Total
Liabilities
|
|
|
10,609,592 |
|
|
|
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 September 30, 2010)
|
|
|
2,848 |
|
|
|
2,851 |
|
Common
stock, $.01 par value; 18,750,000 authorized; issued and
outstanding: 6,561,826 at September 30, 2010; 5,039,468 at December
31, 2009
|
|
|
65,618 |
|
|
|
50,395 |
|
Additional
paid-in capital
|
|
|
48,620,586 |
|
|
|
41,221,613 |
|
Accumulated
other comprehensive income – cumulative
translation adjustments
|
|
|
1,413,377 |
|
|
|
1,303,293 |
|
Accumulated
deficit
|
|
|
(22,777,406 |
) |
|
|
(20,807,095 |
) |
Total
Shareholders’ Equity
|
|
|
27,325,023 |
|
|
|
21,771,057 |
|
Total
Liabilities and Shareholders’ Equity
|
|
$ |
37,934,615 |
|
|
$ |
33,299,875 |
|
See
accompanying consolidated notes.
DERMA
SCIENCES, INC. AND SUBSIDIARIES
Condensed
Consolidated Statements of Operations (Unaudited)
|
|
Three Months ended September 30,
|
|
|
|
2010
|
|
|
2009
|
|
Net
Sales
|
|
$ |
15,096,134 |
|
|
$ |
12,882,425 |
|
Cost
of sales
|
|
|
10,666,204 |
|
|
|
8,838,154 |
|
Gross
Profit
|
|
|
4,429,930 |
|
|
|
4,044,271 |
|
Operating
Expenses
|
|
|
|
|
|
|
|
|
Selling,
general and administrative
|
|
|
4,690,054 |
|
|
|
3,677,182 |
|
Research
and development
|
|
|
175,380 |
|
|
|
70,412 |
|
Total
operating expenses
|
|
|
4,865,434 |
|
|
|
3,747,594 |
|
Operating
(loss) income
|
|
|
(435,504 |
) |
|
|
296,677 |
|
Other
expense, net:
|
|
|
|
|
|
|
|
|
Interest
expense
|
|
|
119,521 |
|
|
|
220,839 |
|
Other
income
|
|
|
(75,530 |
) |
|
|
(69,002 |
) |
Total
other expense
|
|
|
43,991 |
|
|
|
151,837 |
|
(Loss)
income before provision for income taxes
|
|
|
(479,495 |
) |
|
|
144,840 |
|
Provision
for income taxes
|
|
|
23,057 |
|
|
|
5,237 |
|
Net
(Loss) Income
|
|
$ |
(502,552 |
) |
|
$ |
139,603 |
|
Net
(loss) income per common share – basic and diluted
|
|
$ |
(0.08 |
) |
|
$ |
0.03 |
|
Shares
used in computing net (loss) income per common share –
basic
|
|
|
6,561,826 |
|
|
|
5,039,468 |
|
Shares
used in computing net (loss) income per common share –
diluted
|
|
|
6,561,826 |
|
|
|
5,366,413 |
|
See
accompanying consolidated notes.
DERMA
SCIENCES, INC. AND SUBSIDIARIES
Condensed
Consolidated Statements of Operations (Unaudited)
|
|
Nine Months ended September 30,
|
|
|
|
2010
|
|
|
2009
|
|
Net
Sales
|
|
$ |
41,170,621 |
|
|
$ |
34,877,658 |
|
Cost
of sales
|
|
|
28,687,388 |
|
|
|
24,051,984 |
|
Gross
Profit
|
|
|
12,483,233 |
|
|
|
10,825,674 |
|
Operating
Expenses
|
|
|
|
|
|
|
|
|
Selling,
general and administrative
|
|
|
13,603,071 |
|
|
|
11,244,347 |
|
Research
and development
|
|
|
415,232 |
|
|
|
288,338 |
|
Total
operating expenses
|
|
|
14,018,303 |
|
|
|
11,532,685 |
|
Operating
loss
|
|
|
(1,535,070 |
) |
|
|
(707,011 |
) |
Other
expense, net:
|
|
|
|
|
|
|
|
|
Interest
expense
|
|
|
414,120 |
|
|
|
631,909 |
|
Loss
on debt extinguishment
|
|
|
114,072 |
|
|
|
- |
|
Other
income
|
|
|
(253,661 |
) |
|
|
(112,791 |
) |
Total
other expense
|
|
|
274,531 |
|
|
|
519,118 |
|
Loss
before provision (benefit) for income taxes
|
|
|
(1,809,601 |
) |
|
|
(1,226,129 |
) |
Provision
(benefit) for income taxes
|
|
|
160,709 |
|
|
|
(47,151 |
) |
Net
Loss
|
|
$ |
(1,970,310 |
) |
|
$ |
(1,178,978 |
) |
Net
loss per common share – basic and diluted
|
|
$ |
(0.31 |
) |
|
$ |
(0.23 |
) |
Shares
used in computing net loss per common share – basic and
diluted
|
|
|
6,259,205 |
|
|
|
5,028,891 |
|
See
accompanying consolidated notes.
DERMA
SCIENCES, INC. AND SUBSIDIARIES
Condensed
Consolidated Statements of Cash Flows (Unaudited)
|
|
Nine Months Ended September 30,
|
|
|
|
2010
|
|
|
2009
|
|
Operating
Activities
|
|
|
|
|
|
|
Net
Loss
|
|
$ |
(1,970,310 |
) |
|
$ |
(1,178,978 |
) |
Adjustments
to reconcile net loss to net cash (used in) provided by operating
activities:
|
|
|
|
|
|
|
|
|
Depreciation
of equipment and improvements
|
|
|
712,622 |
|
|
|
622,171 |
|
Amortization
of intangible assets
|
|
|
1,248,525 |
|
|
|
987,380 |
|
Amortization
of deferred financing costs
|
|
|
87,501 |
|
|
|
108,512 |
|
Loss
on debt extinguishment
|
|
|
114,072 |
|
|
|
- |
|
Provision
for (recovery of) bad debts
|
|
|
22,269 |
|
|
|
(87,044 |
) |
Allowance
for sales adjustments
|
|
|
54,446 |
|
|
|
630,679 |
|
Provision
for inventory obsolescence
|
|
|
399,355 |
|
|
|
257,702 |
|
Deferred
rent expense
|
|
|
(16,425 |
) |
|
|
51,529 |
|
Compensation
charge for employee stock options
|
|
|
618,278 |
|
|
|
668,658 |
|
Compensation
charge for restricted stock
|
|
|
42,666 |
|
|
|
18,148 |
|
Gain
on sale of equipment
|
|
|
- |
|
|
|
(59,031 |
) |
Deferred
income taxes
|
|
|
(41,109 |
) |
|
|
(21,363 |
) |
Changes
in operating assets and liabilities:
|
|
|
|
|
|
|
|
|
Accounts
receivable
|
|
|
(2,065,267 |
) |
|
|
(394,402 |
) |
Inventories
|
|
|
(2,405,249 |
) |
|
|
1,630,394 |
|
Prepaid
expenses and other current assets
|
|
|
5,556 |
|
|
|
(70,629 |
) |
Other
assets
|
|
|
310,505 |
|
|
|
(452 |
) |
Accounts
payable
|
|
|
814,506 |
|
|
|
(802,634 |
) |
Accrued
expenses and other current liabilities
|
|
|
882,080 |
|
|
|
(763,821 |
) |
Other
long-term liabilities
|
|
|
(8,862 |
) |
|
|
8,788 |
|
Net
cash (used in) provided by operating activities
|
|
|
(1,194,841 |
) |
|
|
1,605,607 |
|
Investing
Activities
|
|
|
|
|
|
|
|
|
Purchase
of equipment and improvements
|
|
|
(337,011 |
) |
|
|
(185,222 |
) |
Purchase
of intangible asset
|
|
|
(2,250,000 |
) |
|
|
- |
|
Proceeds
from sale of equipment
|
|
|
- |
|
|
|
61,000 |
|
Net
cash used in investing activities
|
|
|
(2,587,011 |
) |
|
|
(124,222 |
) |
Financing
Activities
|
|
|
|
|
|
|
|
|
Net
change in bank line of credit
|
|
|
1,352,319 |
|
|
|
(611,016 |
) |
Long-term
debt repayments
|
|
|
(4,050,533 |
) |
|
|
(975,339 |
) |
Net
change in restricted cash
|
|
|
2,032,164 |
|
|
|
(15,142 |
) |
Proceeds
from issuance of stock, net of costs
|
|
|
4,491,279 |
|
|
|
(9,290 |
) |
Net
cash provided by (used in) financing activities
|
|
|
3,825,229 |
|
|
|
(1,610,787 |
) |
Effect
of exchange rate changes on cash
|
|
|
122,604 |
|
|
|
138,362 |
|
Net
increase in cash and cash equivalents
|
|
|
165,981 |
|
|
|
8,960 |
|
Cash
and cash equivalents
|
|
|
|
|
|
|
|
|
Beginning
of period
|
|
|
243,524 |
|
|
|
391,038 |
|
End
of period
|
|
$ |
409,505 |
|
|
$ |
399,998 |
|
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
|
|
$ |
346,443 |
|
|
$ |
494,704 |
|
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 nine months ended September 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) Income per Share –
Net (loss) income per common share – basic is computed by dividing net loss by
the weighted average number of common shares outstanding for the period. Net
(loss) income 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 nine months ended
September 30, 2010 and the nine months ended September 30, 2009 as the effect
would be anti-dilutive.
Total dilutive shares that have or
would have been used to compute diluted income per common share for the three
and nine months ended September 30, 2010 and 2009 are outlined
below:
DERMA
SCIENCES, INC. AND SUBSIDIARIES
Notes to
Condensed Consolidated Financial Statements (Unaudited)
|
|
Three Months Ended September 30,
|
|
|
Nine Months Ended September 30,
|
|
|
|
2010
|
|
|
2009
|
|
|
2010
|
|
|
2009
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
average common shares outstanding – basic
|
|
|
6,561,826 |
|
|
|
5,039,468 |
|
|
|
6,259,205 |
|
|
|
5,028,891 |
|
Dilutive
shares attributable to:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Convertible
preferred stock
|
|
|
– |
|
|
|
285,051 |
|
|
|
– |
|
|
|
– |
|
Warrants
|
|
|
– |
|
|
|
1,575 |
|
|
|
– |
|
|
|
– |
|
Stock
options
|
|
|
– |
|
|
|
40,319 |
|
|
|
– |
|
|
|
– |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Sub-total
dilutive shares
|
|
|
– |
|
|
|
326,945 |
|
|
|
– |
|
|
|
– |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average common
shares outstanding – diluted
|
|
|
6,561,826 |
|
|
|
5,366,413 |
|
|
|
6,259,205 |
|
|
|
5,028,891 |
|
Potentially
dilutive shares excluded as a result of the effects being anti-dilutive are as
follows:
|
|
Three Months Ended September 30,
|
|
|
Nine Months Ended September 30,
|
|
|
|
2010
|
|
|
2009
|
|
|
2010
|
|
|
2009
|
|
Dilutive
shares:
|
|
|
|
|
|
|
|
|
|
|
|
|
Convertible
preferred stock
|
|
|
284,844 |
|
|
|
– |
|
|
|
284,844 |
|
|
|
285,051 |
|
Restricted
common stock
|
|
|
20,000 |
|
|
|
– |
|
|
|
20,000 |
|
|
|
– |
|
Warrants
|
|
|
1,734,531 |
|
|
|
1,097,833 |
|
|
|
1,734,531 |
|
|
|
1,099,407 |
|
Stock
options
|
|
|
1,265,600 |
|
|
|
1,138,821 |
|
|
|
1,265,600 |
|
|
|
1,179,141 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
dilutive shares
|
|
|
3,304,975 |
|
|
|
2,236,654 |
|
|
|
3,304,975 |
|
|
|
2,563,599 |
|
Inventories
include the following:
|
|
September 30,
2010
|
|
|
December 31, 2009
|
|
|
|
|
|
|
|
|
|
|
Finished
goods
|
|
$ |
9,070,100 |
|
|
$ |
7,804,339 |
|
Work
in process
|
|
|
965,226 |
|
|
|
466,365 |
|
Packaging
materials
|
|
|
873,994 |
|
|
|
722,148 |
|
Raw
materials
|
|
|
2,669,978 |
|
|
|
2,496,872 |
|
|
|
|
|
|
|
|
|
|
Total
inventory
|
|
$ |
13,579,298 |
|
|
$ |
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 September 30, 2010 the effective interest rate was 5.75% and
the outstanding balance was $3,658,625.
DERMA
SCIENCES, INC. AND SUBSIDIARIES
Notes to
Condensed Consolidated Financial Statements (Unaudited)
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:
|
|
September
30,
2010
|
|
|
December 31, 2009
|
|
|
|
|
|
|
|
|
|
|
U.S.
term loan
|
|
$ |
- |
|
|
$ |
3,500,000 |
|
Promissory
note
|
|
|
- |
|
|
|
500,000 |
|
Capital
lease obligation
|
|
|
14,503 |
|
|
|
65,036 |
|
|
|
|
|
|
|
|
|
|
Total
debt
|
|
|
14,503 |
|
|
|
4,065,036 |
|
|
|
|
|
|
|
|
|
|
Less:
current maturities
|
|
|
14,503 |
|
|
|
1,759,185 |
|
|
|
|
|
|
|
|
|
|
Long-term
debt
|
|
$ |
- |
|
|
$ |
2,305,851 |
|
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 $14,503 as of September
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 September
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.
DERMA
SCIENCES, INC. AND SUBSIDIARIES
Notes to
Condensed Consolidated Financial Statements (Unaudited)
There are
54,943 shares of series B convertible preferred stock outstanding at September
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 September 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 September 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.
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.
DERMA
SCIENCES, INC. AND SUBSIDIARIES
Notes to
Condensed Consolidated Financial Statements (Unaudited)
Stock
Purchase Warrants
At September 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 243,625 and 207,813 shares of common stock were
granted to officers, directors, agents and employees during the nine months
ended September 30, 2010 and 2009, respectively, with exercise prices ranging
from $3.12 to $5.12 per share. During the nine months ended September 30, 2010
and 2009, 16,249 and 1,875 plan options were forfeited, respectively, and during
the nine months ended September 30, 2010, 3,751 were exercised. As of September
30, 2010, options to purchase 1,082,974 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 nine months ended September 30, 2010 and 2009, 24,375
and 29,625 non-plan options expired. As of September 30, 2010, non-plan options
to purchase 182,626 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 nine
months ended September 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
|
|
|
243,625 |
|
|
$ |
5.09 |
|
|
|
207,813 |
|
|
$ |
3.04 |
|
Forfeited
|
|
|
(16,249 |
) |
|
$ |
4.43 |
|
|
|
(1,875 |
) |
|
$ |
5.60 |
|
Expired
|
|
|
(24,375 |
) |
|
$ |
6.00 |
|
|
|
(29,625 |
) |
|
$ |
8.88 |
|
Exercised
|
|
|
(3,751 |
) |
|
$ |
3.33 |
|
|
|
- |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding
– September 30
|
|
|
1,265,600 |
|
|
$ |
5.08 |
|
|
|
1,179,141 |
|
|
$ |
5.04 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercisable
at September 30
|
|
|
986,498 |
|
|
$ |
5.19 |
|
|
|
848,906 |
|
|
$ |
5.36 |
|
During the nine months ended September
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 nine months
ended September 30, 2010 and 2009 were as follows:
|
|
Three Months Ended September 30,
|
|
|
Nine Months Ended September 30,
|
|
|
|
2010
|
|
|
2009
|
|
|
2010
|
|
|
2009
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Risk-free
interest rate
|
|
|
1.78 |
% |
|
|
2.88 |
% |
|
|
2.54 |
% |
|
|
2.31 |
% |
Volatility
factor
|
|
|
107.5 |
% |
|
|
83.73 |
% |
|
|
79.97 |
% |
|
|
92.16 |
% |
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 nine months ended September 30, 2010 and
2009 was $3.59 and $2.34, respectively. During the three and nine
months ended September 30, 2010 and 2009, stock option compensation expense was
recorded as follows:
DERMA
SCIENCES, INC. AND SUBSIDIARIES
Notes to
Condensed Consolidated Financial Statements (Unaudited)
|
|
Three Months
Ended September 30,
|
|
|
Nine Months
Ended September 30,
|
|
|
|
2010
|
|
|
2009
|
|
|
2010
|
|
|
2009
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost
of sales
|
|
$ |
18,885 |
|
|
$ |
23,327 |
|
|
$ |
58,383 |
|
|
$ |
73,764 |
|
Selling,
general and administrative expenses
|
|
|
182,262 |
|
|
|
169,461 |
|
|
|
559,895 |
|
|
|
594,894 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
stock option compensation expense
|
|
$ |
201,147 |
|
|
$ |
192,788 |
|
|
$ |
618,278 |
|
|
$ |
668,658 |
|
As of September 30, 2010, there was
$591,703 of unrecognized compensation cost related to non-vested service and
$59,565 non-vested performance based awards granted under the plan. These costs
are expected to be recognized over the options’ remaining weighted average
vesting period of 1.46 years for the service and .25 years for the performance
based awards.
For the
nine months ended September 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 nine months ended September 30, 2010,
$42,666 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 nine months
ended September 30, 2009, $18,148 was recorded in operating expense for these
grants.
Shares
Reserved for Future Issuance
At September 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
|
|
|
167,026 |
|
Common
stock options outstanding
|
|
|
1,265,600 |
|
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
|
|
|
3,742,626 |
|
DERMA
SCIENCES, INC. AND SUBSIDIARIES
Notes to
Condensed Consolidated Financial Statements (Unaudited)
6.
|
Comprehensive
(Loss) Income
|
The
Company’s comprehensive (loss) income was as follows:
|
|
Three Months Ended
September 30,
|
|
|
Nine Months Ended
September 30,
|
|
|
|
2010
|
|
|
2009
|
|
|
2010
|
|
|
2009
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
(loss) income as reported
|
|
$ |
(502,552 |
) |
|
$ |
139,603 |
|
|
$ |
(1,970,310 |
) |
|
$ |
(1,178,978 |
) |
Other
comprehensive income: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Foreign
currency translation adjustment
|
|
|
181,751 |
|
|
|
363,948 |
|
|
|
110,084 |
|
|
|
610,150 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive
(loss) income
|
|
$ |
(320,801 |
) |
|
$ |
503,551 |
|
|
$ |
(1,860,226 |
) |
|
$ |
(568,828 |
) |
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 September 30, 2010
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Wound
Care
|
|
|
Wound
Closure-
Specialty Securement
Devices
|
|
|
Skin
Care
|
|
|
Other
|
|
|
Total
Company
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
sales
|
|
$ |
14,511,806 |
|
|
$ |
428,476 |
|
|
$ |
155,852
|
|
|
|
- |
|
|
$ |
15,096,134 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross
profit
|
|
|
4,165,478 |
|
|
|
228,010 |
|
|
|
36,442 |
|
|
|
- |
|
|
|
4,429,930 |
|
Total
expenses
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
$ |
(4,932,482 |
) |
|
|
(4,932,482 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
loss
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
(502,552 |
) |
|
|
Three
Months Ended September 30, 2009
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
sales
|
|
$ |
12,289,311 |
|
|
$ |
409,565 |
|
|
$ |
183,549
|
|
|
|
- |
|
|
$ |
12,882,425 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross
profit
|
|
|
3,765,137 |
|
|
|
231,070 |
|
|
|
48,064 |
|
|
|
- |
|
|
|
4,044,271 |
|
Total
expenses
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
$ |
(3,904,668 |
) |
|
|
(3,904,668 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
139,603
|
|
DERMA
SCIENCES, INC. AND SUBSIDIARIES
Notes to
Condensed Consolidated Financial Statements (Unaudited)
Nine Months Ended September 30,
2010
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Wound Care
|
|
|
Wound
Closure-
Specialty Securement Devices
|
|
|
Skin Care
|
|
|
Other
|
|
|
Total
Company
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
sales
|
|
$ |
39,451,842 |
|
|
$ |
1,303,627 |
|
|
$ |
415,152
|
|
|
|
- |
|
|
$ |
41,170,621 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross
profit
|
|
|
11,675,826 |
|
|
|
705,387 |
|
|
|
102,020 |
|
|
|
- |
|
|
|
12,483,233 |
|
Total
expenses
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
$ |
(14,453,543 |
) |
|
|
(14,453,543 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
loss
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
(1,970,310 |
) |
|
|
Nine Months Ended September 30,
2009
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
sales
|
|
$ |
33,023,590 |
|
|
$ |
1,307,327 |
|
|
$ |
546,741 |
|
|
|
- |
|
|
$ |
34,877,658 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross
profit
|
|
|
9,969,307 |
|
|
|
714,272 |
|
|
|
142,095 |
|
|
|
- |
|
|
|
10,825,674 |
|
Total
expenses
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
$ |
(12,004,652 |
) |
|
|
(12,004,652 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
loss
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
(1,178,978 |
) |
The following table presents net sales
by geographic region.
|
|
Three Months Ended
September 30,
|
|
|
Nine Months Ended
September 30,
|
|
|
|
2010
|
|
|
2009
|
|
|
2010
|
|
|
2009
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
United
States
|
|
|
72 |
% |
|
|
72 |
% |
|
|
69 |
% |
|
|
72 |
% |
Canada
|
|
|
22 |
% |
|
|
23 |
% |
|
|
25 |
% |
|
|
22 |
% |
Other
|
|
|
6 |
% |
|
|
5 |
% |
|
|
6 |
% |
|
|
6 |
% |
For the nine months ended September 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 September 30, 2010.
The
Company recorded a $160,709 foreign income tax provision for the nine months
ended September 30, 2010 and a $47,151 foreign income tax benefit for the nine
months ended September 30, 2009 based on the operating results of the Company’s
wholly owned Canadian subsidiary. The 2010 provision was comprised of $201,818
current foreign tax payable and $41,109 deferred foreign tax benefit while the
2009 benefit was comprised of $25,788 current foreign tax and $21,363 deferred
foreign tax benefits. No benefit was realized for the Company’s net loss from
U.S. operations in the nine months ended September 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.
DERMA
SCIENCES, INC. AND SUBSIDIARIES
Notes to
Condensed Consolidated Financial Statements (Unaudited)
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.
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.
10. Subsequent
Events
On
November 2, 2010, the Company was notified that it had been awarded a $244,479
grant from the U. S. government under the HR: 3590 – Patient Protection and
Affordable Care Act (the “Act”) in connection with DSC127 its novel
pharmaceutical product currently undergoing its Phase II trial. Applicants were
required to submit detailed information demonstrating that their research
conformed to the parameters of the Act, along with a summary of qualifying
expenditures that formed the basis for the award.
Item
2. Management's Discussion and Analysis of Financial Condition and Results of
Operations
Quarter
Ended September 30, 2010 Compared to Quarter Ended September 30,
2009
Overview
The
following table highlights the quarter ended September 30, 2010 versus 2009
operating results:
|
|
Quarter
Ended September 30,
|
|
|
Variance
|
|
|
|
2010
|
|
|
2009
|
|
|
|
|
Gross
Sales
|
|
$ |
17,653,812 |
|
|
$ |
15,356,917 |
|
|
$ |
2,296,895 |
|
|
|
15.0 |
% |
Sales
adjustments
|
|
|
(2,557,678 |
) |
|
|
(2,474,492 |
) |
|
|
(83,186 |
) |
|
|
3.4 |
% |
Net
sales
|
|
|
15,096,134 |
|
|
|
12,882,425 |
|
|
|
2,213,709 |
|
|
|
17.2 |
% |
Cost
of sales
|
|
|
10,666,204 |
|
|
|
8,838,154 |
|
|
|
1,828,050 |
|
|
|
20.7 |
% |
Gross
profit
|
|
|
4,429,930 |
|
|
|
4,044,271 |
|
|
|
385,659 |
|
|
|
9.5 |
% |
Selling,
general and administrative expense
|
|
|
4,690,054 |
|
|
|
3,677,182 |
|
|
|
1,012,872 |
|
|
|
27.5 |
% |
Research
and development expense
|
|
|
175,380 |
|
|
|
70,412 |
|
|
|
104,968 |
|
|
|
149.1 |
% |
Interest
expense
|
|
|
119,521 |
|
|
|
220,839 |
|
|
|
(101,318 |
) |
|
|
(45.9 |
)% |
Other
income, net
|
|
|
(75,530 |
) |
|
|
(69,002 |
) |
|
|
(6,528 |
) |
|
|
9.5 |
% |
Total
expenses
|
|
|
4,909,425 |
|
|
|
3,899,431 |
|
|
|
1,009,994 |
|
|
|
25.9 |
% |
(Loss)
income before income taxes
|
|
|
(479,495 |
) |
|
|
144,840 |
|
|
|
(624,335 |
) |
|
|
431.1 |
% |
Provision
for income taxes
|
|
|
23,057 |
|
|
|
5,237 |
|
|
|
17,820 |
|
|
|
|
|
Net
(loss) income
|
|
$ |
(502,552 |
) |
|
$ |
139,603 |
|
|
$ |
(642,155 |
) |
|
|
|
|
Gross
to Net Sales Adjustments
Gross to
net sales adjustments comprise the following:
|
|
Quarter Ended September 30,
|
|
|
2010
|
|
2009
|
Gross
Sales
|
|
$
|
17,653,812
|
|
|
$
|
15,356,917
|
|
Trade
rebates
|
|
|
(1,868,953
|
)
|
|
|
(1,820,697
|
)
|
Distributor
fees
|
|
|
(301,711
|
)
|
|
|
(266,783
|
)
|
Sales
incentives
|
|
|
(185,638
|
)
|
|
|
(164,711
|
)
|
Returns
and allowances
|
|
|
(79,910
|
)
|
|
|
(118,355
|
)
|
Cash
discounts
|
|
|
(121,466
|
)
|
|
|
(103,946
|
)
|
Total
adjustments
|
|
|
(2,557,678
|
)
|
|
|
(2,474,492
|
)
|
Net
sales
|
|
$
|
15,096,134
|
|
|
$
|
12,882,425
|
|
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 increase in sales incentive expense reflects a
increase in the number of the traditional wound care and private label sales
incentive programs, partially offset by lower first aid products sales incentive
programs in 2010 versus 2009. The sales returns and allowances decrease is due
to a lower incidence of advanced wound care, private label and first aid product
returns in 2010 versus 2009. 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 September 30, 2010 and 2009
is outlined below:
|
|
Quarter Ended September 30,
|
|
|
|
2010
|
|
|
2009
|
|
Beginning
balance – June 30
|
|
$ |
2,385,569 |
|
|
$ |
2,309,304 |
|
Rebates
paid
|
|
|
(1,874,922 |
) |
|
|
(1,759,195 |
) |
Rebates
accrued
|
|
|
1,868,953 |
|
|
|
1,820,697 |
|
Ending
balance – September 30
|
|
$ |
2,379,600 |
|
|
$ |
2,370,806 |
|
The
$5,969 decrease in the trade rebate reserve balance for the three months ended
September 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 September 30, 2010 versus 2009 product line net
sales and gross profit:
|
|
Quarter Ended September 30,
|
|
|
Variance
|
|
|
|
2010
|
|
|
2009
|
|
|
|
|
Net
Sales
|
|
$ |
15,096,134 |
|
|
$ |
12,882,425 |
|
|
$ |
2,213,709 |
|
|
|
17.2 |
% |
Cost
of sales
|
|
|
10,666,204 |
|
|
|
8,838,154 |
|
|
|
1,828,050 |
|
|
|
20.7 |
% |
Gross
Profit
|
|
$ |
4,429,930 |
|
|
$ |
4,044,271 |
|
|
$ |
385,659 |
|
|
|
9.5 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross
Profit %
|
|
|
29.3 |
% |
|
|
31.4 |
% |
|
|
|
|
|
|
|
|
Consolidated
net sales increased $2,213,709, or 17.2% (16.0% adjusted for exchange), in 2010
versus 2009. Canadian net sales increased $251,138, or 8.7%, to $3,144,667 in
2010 from $2,893,529 in 2009. This increase was driven by favorable exchange of
$152,221 associated with a 5.3% strengthening of the Canadian dollar, coupled
with sales growth of $98,917. The sales growth reflects the impact of real
growth of $499,229, or 17.3% due to higher demand, partially offset by an
inventory decrease on the part of our exclusive Canadian distributor of $400,312
during the quarter. U.S. net sales increased $1,622,782, or 16.2%, to
$11,611,678 in 2010 from $9,988,896 in 2009. The increase was principally driven
by higher first aid product sales of $1,413,528, or 42.7%, and advanced wound
care sales of $458,754, or 21.3%, partially offset by lower private label sales
of $279,539, or 12.5%. The balance of U.S. sales consisting of traditional wound
care, specialty fixation, burn care and skin care and bathing sales were up 1.3%
quarter to quarter. The increase in first aid products sales reflects new
business, improving demand and the spot sale of slow moving inventory. The
higher advanced wound care sales reflect continued growth of our new products in
response to expanded sales and marketing efforts. The decrease in private label
sales reflects the loss of business and timing. Advanced wound care sales of
$339,789 associated with our recently initiated international growth strategy
also contributed to the consolidated net sales increase.
Consolidated
advanced wound care sales increased $852,311, or 38.1%, to $3,087,831 in 2010
from $2,235,520 in 2009. All other sales (core sales) increased $1,361,398, or
12.8%, to $12,008,303 in 2010 from $10,646,905 in 2009.
Consolidated
gross profit increased $385,659, or 9.5%, in 2010 versus 2009. The consolidated
gross profit margin percentage decreased to 29.3% in 2010 from 31.4% in 2009.
The increase in gross profit dollars reflects the higher sales, partially offset
by the lower gross profit margin percentage. The lower gross margin profit
percentage reflects the increase in lower margined core sales, coupled with
increasing product costs and higher obsolescence and transportation expenses,
partially offset by the benefit of increasing higher margined advanced wound
care sales.
Selling,
General and Administrative Expenses
The
following table highlights September 30, 2010 versus 2009 selling, general and
administrative expenses by type:
|
|
Quarter Ended September 30,
|
|
|
Variance
|
|
|
|
2010
|
|
|
2009
|
|
|
|
|
Distribution
|
|
$ |
436,772 |
|
|
$ |
443,592 |
|
|
$ |
(6,820 |
) |
|
|
(1.5 |
)% |
Marketing
|
|
|
405,516 |
|
|
|
371,624 |
|
|
|
33,892 |
|
|
|
9.1 |
% |
Sales
|
|
|
1,819,067 |
|
|
|
1,306,140 |
|
|
|
512,927 |
|
|
|
39.3 |
% |
General
and administrative
|
|
|
2,028,699 |
|
|
|
1,555,826 |
|
|
|
472,873 |
|
|
|
30.4 |
% |
Total
|
|
$ |
4,690,054 |
|
|
$ |
3,677,182 |
|
|
$ |
1,012,872 |
|
|
|
27.5 |
% |
Selling,
general and administrative expenses increased $1,012,872, or 27.5% (26.7%
adjusted for exchange), in 2010 versus 2009, including an increase of $32,349 in
Canadian selling, general and administrative expenses attributable to
exchange.
Distribution
expense decreased $6,820, or 1.5% (2.2% adjusted for exchange), in 2010 versus
2009, including an increase of $2,925 due to exchange. This decrease
reflects lower labor requirements in the Houston distribution center, partially
offset by higher labor requirements in St. Louis coupled with lower operating
expenses.
Marketing
expense increased $33,892, or 9.1% (8.8% adjusted for exchange), in 2010 versus
2009, including an increase of $549 due to exchange. The increase is principally
attributable to higher U.S. compensation and recruiting costs in support of our
growth initiatives. Lower overall first aid product spending also
contributed.
Sales
expense increased $512,927, or 39.3% (38.5% adjusted for exchange), in 2010
versus 2009. Expenses in Canada increased $10,752 (including a $9,871 increase
related to exchange) due to higher compensation and benefit and commission
costs, partially offset by lower group purchasing organization
fees. Expenses in the U.S. increased $304,149. 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 June, 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 $198,026 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 $472,873, or 30.4% (29.2% adjusted for
exchange), in 2010 versus 2009. Expenses in Canada increased $31,510 (including
a $19,004 increase related to exchange). Net of exchange, expenses were up
$12,506 driven principally by compensation and benefits associated with
inflationary increases and one new position, coupled with higher insurance and
audit expenses. Expenses in the U. S. increased $414,878. This increase reflects
incremental amortization expense of $112,700 associated with the worldwide
Medihoney license agreement signed in February 2010, higher legal expense
of $89,600 principally associated with intellectual property
maintenance expenses, higher board related expense of $72,900, higher planned
investor relations expenses of $43,200 designed to increase investor awareness
and improve our stock’s trading volume, bad debt expense of $35,900, together
with higher travel, professional service and inflation driven compensation and
benefit expenses. Incremental international expenses of $26,485
consisting 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 $104,968 to $175,380 in 2010 from $70,412 in
2009. The increase reflects incremental patient enrollment costs leading up to
the close out of trial enrollment in September, 2010 together with ongoing
monthly data management expenses that began in October 2009.
Interest
Expense
Interest
expense decreased $101,318 to $119,521 in 2010 from $220,839 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 timing related
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. Ongoing line of credit interest was higher quarter to
quarter due to higher borrowing levels and slightly higher interest
rates.
Other
Income
Other
income increased $6,528 to $75,530 in 2010 from $69,002 in 2009. The main
drivers for the net quarter to quarter increase were higher royalty and
miscellaneous income, partially offset by lower exchange income.
Income
Taxes
We
recorded a $23,057 foreign income tax provision for 2010 consisting of a $25,174
current foreign tax provision and a $2,117 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 $5,237 foreign income tax provision
consisting of a $3,896 current foreign tax provision and a $1,341 deferred
foreign tax provision 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) Income
We
generated a net loss of $502,552, or ($0.08) per share (basic and diluted), in
2010 compared to a net income of $139,603, or $0.03 per share (basic and
diluted), in 2009.
Nine
Months Ended September 30, 2010 Compared to Nine Months Ended September 30,
2009
Overview
The
following table highlights the nine months ended September 30, 2010 versus 2009
operating results:
|
|
Nine Months Ended September
30,
|
|
|
Variance
|
|
|
|
2010
|
|
|
2009
|
|
|
|
|
Gross
Sales
|
|
$ |
48,918,341 |
|
|
$ |
41,668,350 |
|
|
$ |
7,249,991 |
|
|
|
17.4 |
% |
Sales
adjustments
|
|
|
(7,747,720 |
) |
|
|
(6,790,692 |
) |
|
|
(957,028 |
) |
|
|
14.1 |
% |
Net
sales
|
|
|
41,170,621 |
|
|
|
34,877,658 |
|
|
|
6,292,963 |
|
|
|
18.0 |
% |
Cost
of sales
|
|
|
28,687,388 |
|
|
|
24,051,984 |
|
|
|
4,635,404 |
|
|
|
19.3 |
% |
Gross
profit
|
|
|
12,483,233 |
|
|
|
10,825,674 |
|
|
|
1,657,559 |
|
|
|
15.3 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling,
general and administrative expense
|
|
|
13,603,071 |
|
|
|
11,244,347 |
|
|
|
2,358,724 |
|
|
|
21.0 |
% |
Research
and development expense
|
|
|
415,232 |
|
|
|
288,338 |
|
|
|
126,894 |
|
|
|
44.0 |
% |
Interest
expense
|
|
|
414,120 |
|
|
|
631,909 |
|
|
|
(217,789 |
) |
|
|
(34.5 |
)% |
Loss
on debt extinguishment
|
|
|
114,072 |
|
|
|
- |
|
|
|
114,072 |
|
|
|
|
|
Other
income, net
|
|
|
(253,661 |
) |
|
|
(112,791 |
) |
|
|
(140,870 |
) |
|
|
124.9 |
% |
Total
expenses
|
|
|
14,292,834 |
|
|
|
12,051,803 |
|
|
|
2,241,031 |
|
|
|
18.6 |
% |
Loss
before income taxes
|
|
|
(1,809,601 |
) |
|
|
(1,226,129 |
) |
|
|
(583,472 |
) |
|
|
47.6 |
% |
Provision
(benefit) for income taxes
|
|
|
160,709 |
|
|
|
(47,151 |
) |
|
|
207,860 |
|
|
|
|
|
Net
loss
|
|
$ |
(1,970,310 |
) |
|
$ |
(1,178,978 |
) |
|
$ |
(791,332 |
) |
|
|
67.1 |
% |
Gross
to Net Sales Adjustments
Gross to
net sales adjustments comprise the following:
|
|
Nine Months Ended September 30,
|
|
|
|
2010
|
|
|
2009
|
|
Gross
Sales
|
|
$ |
48,918,341 |
|
|
$ |
41,668,350 |
|
Trade
rebates
|
|
|
(5,772,856 |
) |
|
|
(4,934,121 |
) |
Distributor
fees
|
|
|
(970,664 |
) |
|
|
(711,980 |
) |
Sales
incentives
|
|
|
(422,610 |
) |
|
|
(453,411 |
) |
Returns
and allowances
|
|
|
(253,372 |
) |
|
|
(384,403 |
) |
Cash
discounts
|
|
|
(328,218 |
) |
|
|
(306,777 |
) |
Total
adjustments
|
|
|
(7,747,720 |
) |
|
|
(6,790,692 |
) |
Net
sales
|
|
$ |
41,170,621 |
|
|
$ |
34,877,658 |
|
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 first aid products sales incentive programs,
partially offset by an expansion of the incentive plan with a significant
customer 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 nine
month roll forward of the trade rebate accruals at September 30, 2010 and 2009
is outlined below:
|
|
Nine Months Ended September 30,
|
|
|
|
2010
|
|
|
2009
|
|
Beginning
balance – January 1
|
|
$ |
2,493,232 |
|
|
$ |
2,660,086 |
|
Rebates
paid
|
|
|
(5,886,488 |
) |
|
|
(5,223,401 |
) |
Rebates
accrued
|
|
|
5,772,856 |
|
|
|
4,934,121 |
|
Ending
balance – September 30
|
|
$ |
2,379,600 |
|
|
$ |
2,370,806 |
|
The
$113,632 decrease in the trade rebate reserve balance for the nine months ended
September 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 September 30, 2010 versus 2009 product line net
sales and gross profit:
|
|
Nine Months Ended September
30,
|
|
|
Variance
|
|
|
|
2010
|
|
|
2009
|
|
|
|
|
Net
Sales
|
|
$ |
41,170,621 |
|
|
$ |
34,877,658 |
|
|
$ |
6,292,963 |
|
|
|
18.0 |
% |
Cost
of sales
|
|
|
28,687,388 |
|
|
|
24,051,984 |
|
|
|
4,635,404 |
|
|
|
19.3 |
% |
Gross
Profit
|
|
$ |
12,483,233 |
|
|
$ |
10,825,674 |
|
|
$ |
1,657,559 |
|
|
|
15.3 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross
Profit %
|
|
|
30.3 |
% |
|
|
31.0 |
% |
|
|
|
|
|
|
|
|
Consolidated
net sales increased $6,292,963, or 18.0% (15.4% adjusted for exchange), in 2010
versus 2009. Canadian net sales increased $2,411,374, or 30.7%, to $10,254,592
in 2010 from $7,843,218 in 2009. This increase was driven by favorable exchange
of $936,436 associated with an 11.4% strengthening of the Canadian dollar,
coupled with sales growth of $1,474,938. The sales growth reflects the impact of
real growth of $469,532, or 6.0%, due to higher demand, coupled with $1,005,070
related to an inventory build on the part of our exclusive Canadian distributor.
U.S. net sales increased $3,124,853, or 11.6%, to $30,159,293 in 2010 from
$27,034,440 in 2009. The increase was principally driven by higher first aid
product sales of $1,892,724, or 20.2%, and advanced wound care sales of
$1,657,357, or 31.8%, partially offset by lower private label sales of $311,378,
or 5.2%, and skin care and bathing sales of $136,536, or 26.8%. The balance of
U.S. sales consisting of traditional wound care, burn care and specialty
fixation were flat period to period. The increase in first aid products sales
reflects new business, improving demand and the spot sale of slow moving
inventory. The higher advanced wound care sales reflect continued
growth of our new products in response to expanded sales and marketing efforts.
Advanced wound care sales of $756,736 associated with our recently initiated
international growth strategy also contributed to the consolidated net sales
increase.
Consolidated
advanced wound care sales increased $2,568,563, or 48.1%, to $7,906,220 in 2010
from $5,337,657 in 2009. All other sales (core sales) increased $3,724,400, or
12.6%, to $33,264,401 in 2010 from $29,540,001 in 2009.
Consolidated
gross profit increased $1,657,559, or 15.3%, in 2010 versus 2009. The
consolidated gross profit margin percentage decreased to 30.3% in 2010 from
31.0% in 2009. The increase in gross profit dollars reflects the higher sales,
partially offset by the lower gross profit margin percentage. The lower gross
margin percentage reflects the increase in lower margined core sales, coupled
with increasing product costs and higher obsolescence and transportation
expenses, partially offset by the benefit of increasing higher margined advanced
wound care sales.
Selling,
General and Administrative Expenses
The
following table highlights September 30, 2010 versus 2009 selling, general and
administrative expenses by type:
|
|
Nine Months Ended September 30,
|
|
|
Variance
|
|
|
|
2010
|
|
|
2009
|
|
|
|
|
Distribution
|
|
$ |
1,342,207 |
|
|
$ |
1,331,067 |
|
|
$ |
11,140 |
|
|
|
0.1 |
% |
Marketing
|
|
|
1,258,378 |
|
|
|
1,201,411 |
|
|
|
56,967 |
|
|
|
4.7 |
% |
Sales
|
|
|
4,947,452 |
|
|
|
3,743,003 |
|
|
|
1,204,449 |
|
|
|
32.2 |
% |
General
and administrative
|
|
|
6,055,034 |
|
|
|
4,968,866 |
|
|
|
1,086,168 |
|
|
|
21.9 |
% |
Total
|
|
$ |
13,603,071 |
|
|
$ |
11,244,347 |
|
|
$ |
2,358,724 |
|
|
|
21.0 |
% |
Selling,
general and administrative expenses increased $2,358,724, or 21.0% (19.8%
adjusted for exchange), in 2010 versus 2009, including an increase of $136,864
in Canadian selling, general and administrative expenses attributable to
exchange.
Distribution
expense increased $11,140, or 0.1%, in 2010 versus 2009 due to exchange.
Excluding exchange, distribution expenses decreased $10,132. 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 $56,967, or 4.7% (3.8% adjusted for exchange), in 2010 versus
2009, including an increase of $11,162 due to exchange. The increase is
attributable to higher U.S. advanced wound care related compensation, recruiting
and literature expenses, coupled with higher Canadian promotion and show
expenses in support of our advanced wound care growth initiatives, partially
offset by lower promotion and sampling expenses.
Sales
expense increased $1,204,449, or 32.2% (30.6% adjusted for exchange), in 2010
versus 2009. Expenses in Canada increased $104,099 (including a $60,358 increase
related to exchange) due to higher compensation and benefit costs, travel and
sales volume related group purchasing organization expenses. Expenses
in the U. S. increased $700,527. This increase is attributable to incremental
costs of approximately $677,000 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,
higher sales volume related first aid products broker commission expense of
$86,000, higher sales tracing fees of $52,000 and higher customer service
expenses of $36,000 associated with the annualization of the staffing increases
implemented in 2009. Offsetting these increases were lower first aid
products operating costs associated with the termination of an executive in the
first quarter 2010 and lower non first aid products related operating expenses.
Also contributing were incremental international expenses of $399,823 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 $1,086,168, or 21.9% (19.1% adjusted for
exchange), in 2010 versus 2009. Expenses in Canada increased $203,900 (including
a $136,864 increase related to exchange). Net of exchange, expenses were up
$67,036 driven principally by compensation and benefits associated with
inflationary increases and one new position, information technology expenses
related to software upgrades and professional service expenses. Expenses in the
U.S. increased $762,549. This increase reflects incremental amortization expense
of $262,300 associated with the worldwide Medihoney license agreement signed in
February 2010, higher planned investor relations expenses of $147,400 designed
to increase investor awareness, bad debt expense of $103,300, higher legal fees
of $90,200 principally associated with intellectual property maintenance, higher
board related expense of $81,600 together with higher travel,
professional services and inflation driven compensation and benefit expenses,
partially offset by lower equity based compensation
expense. Incremental international expenses of $119,719 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 $126,894 to $415,232 in 2010 from $288,338 in
2009. The increase reflects data management expense of $90,000 plus incremental
patient enrollment related costs of $64,000 leading up to the close out of trial
enrolment in September 2010. Offsetting these increases were lower patent
maintenance related legal costs and other expenses.
Interest
Expense
Interest
expense decreased $217,789 to $414,120 in 2010 from $631,909 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 attributable to higher borrowing levels and 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 $140,870 to $253,661 in 2010 from $112,791 in 2009. The main
drivers for the net period to period increase was an exchange gain of $173,000
and higher royalty income $21,000, 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 $160,709 foreign income tax provision for 2010 consisting of a
$201,818 current foreign tax provision and a $41,109 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 $47,151 foreign income tax benefit
consisting of a $25,788 current tax and a $21,363 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 $1,970,310, or $0.31 per share (basic and diluted), in
2010 compared to a net loss of $1,178,978, or $0.23 per share (basic and
diluted), in 2009.
Liquidity and Capital
Resources
Cash
Flow and Working Capital
At
September 30, 2010 and December 31, 2009, we had cash and cash equivalents of
$409,505 and $243,524, respectively. The $165,981 increase in cash reflects net
cash provided by financing activities of $3,825,229 partially offset by cash
used in investing activities of $2,587,011 and operating activities of
$1,194,841, together with cash provided as a result of exchange rate changes of
$122,604.
Net cash
used in operating activities of $1,194,841 stems from $1,271,890 cash provided
from operations (net loss plus non-cash items), together with $2,466,731 cash
used from the net change in operating assets and liabilities. Higher
receivables and inventory, offset by accounts payable and accrued liabilities,
were the main drivers behind the net cash used in connection with the net change
in operating assets and liabilities. The increase in receivables reflects a
higher level of current sales, 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 $2,587,011 reflects $2,250,000 cash used to
purchase the worldwide Medihoney license rights and capital expenditures of
$337,011.
Net cash
provided by financing activities of $3,825,229 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;
$2,032,164 from funds previously restricted; and $1,352,319 from an increase in
the line of credit. Offsetting these inflows were $4,050,533 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 $2,796,225 at September 30, 2010 to $9,587,806 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 $409,505, together with available cash under our line of credit of
$1,194,591, we had $1,604,096 of available liquidity at September 30, 2010,
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.
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 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 three months, at which time we expect to be able to begin 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. We have establish a direct
presence in Europe 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 $1,870,000 (excluding any grant funding
received), including $1,468,116 spent through September 2010. We plan to
continue with this investment and anticipate spending approximately
$401,884 to complete the Phase II trial. Enrollment in the trial was
closed at the end of September. We expect to announce top-line
efficiency data by the end of the year or early next year and complete the
study and file our report with the FDA by the end of September 2011. In
November 2010, we received a $244,479 grant from the federal government
under the Patient Protection and Affordable Care Act to assist in the
financing of the trial.
|
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
September 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
September 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.
Item
4. CONTROLS AND PROCEDURES
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 September 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 nine months ended September
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 $1,970,310 for the nine months ended September 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 September 30, 2010, we had an
accumulated deficit of $22,777,406 (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
3,304,975 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 nine 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
*
|
|
$ |
4.40 |
|
|
$ |
9.00 |
|
(*)
January 1 through September 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: November
11, 2010
|
By:
|
/s/ John E. Yetter
|
|
|
|
John
E. Yetter, CPA
|
|
|
Chief
Financial Officer
|