UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Form 10-Q
| (Mark One) | ||
| þ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) | |
| OF THE SECURITIES EXCHANGE ACT OF 1934 | ||
| For the Quarterly Period Ended June 30, 2003 | ||
| or | ||
| o | 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: 000-27212
Endocare, Inc.
|
Delaware
|
33-0618093 | |
| (State of incorporation) | (IRS Employer Identification No.) |
201 Technology Drive, Irvine, California 92618
(949) 450-5400
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. (1) Yes o No þ (2) Yes þ No o
Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes þ No o
The number of shares of the Registrant’s common stock, par value $.001 per share, outstanding at May 31, 2004 was 24,007,482.
ENDOCARE, INC. AND SUBSIDIARIES
1
EXPLANATORY NOTE: We are filing this past due quarterly report on Form 10-Q for the quarter ended June 30, 2003 concurrently with our filing of past due quarterly reports on Form 10-Q for the quarters ended September 30, 2002, March 31, 2003 and September 30, 2003. Except as otherwise noted, this quarterly report on Form 10-Q speaks as of the date of filing. Accordingly, statements in this report on Form 10-Q containing the words (i) “now,” “currently,” “present,” “to date,” and words of similar import, or (ii) “believes,” “intends,” “anticipates,” “expects,” “estimates,” “should,” “could,” “may,” “plans,” “planned,” and words of similar import, are used to refer to conditions existing on the date of filing of this quarterly report on Form 10-Q.
PART I — FINANCIAL INFORMATION
| Item 1. | Condensed Consolidated Financial Statements |
ENDOCARE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
| Three Months Ended June 30, | Six Months Ended June 30, | |||||||||||||||||
| 2003 | 2002 | 2003 | 2002 | |||||||||||||||
| (Restated) | (Restated) | |||||||||||||||||
|
Total revenues
|
$ | 7,490,367 | $ | 8,785,887 | $ | 15,152,151 | $ | 15,425,913 | ||||||||||
|
Costs and expenses:
|
||||||||||||||||||
|
Cost of revenues
|
3,469,503 | 4,188,170 | 7,465,548 | 7,492,906 | ||||||||||||||
|
Research and development
|
365,437 | 827,279 | 698,250 | 1,561,854 | ||||||||||||||
|
Selling, general and administrative
|
11,979,009 | 9,259,520 | 21,526,866 | 15,666,683 | ||||||||||||||
|
Total costs and expenses
|
15,813,949 | 14,274,969 | 29,690,664 | 24,721,443 | ||||||||||||||
|
Loss from operations
|
(8,323,582 | ) | (5,489,082 | ) | (14,538,513 | ) | (9,295,530 | ) | ||||||||||
|
Gain on divestitures, net
|
9,944,424 | — | 9,944,424 | — | ||||||||||||||
|
Interest income
|
218,096 | 284,030 | 439,325 | 617,197 | ||||||||||||||
|
Interest expense
|
(22,521 | ) | — | (27,298 | ) | — | ||||||||||||
|
Income (loss) before minority interests
|
1,816,417 | (5,205,052 | ) | (4,182,062 | ) | (8,678,333 | ) | |||||||||||
|
Minority interests
|
(154,965 | ) | — | (244,384 | ) | — | ||||||||||||
|
Net income (loss)
|
$ | 1,661,452 | $ | (5,205,052 | ) | $ | (4,426,446 | ) | $ | (8,678,333 | ) | |||||||
|
Net income (loss) per share of common stock:
|
||||||||||||||||||
|
Basic
|
$ | .07 | $ | (.22 | ) | $ | (.18 | ) | $ | (.37 | ) | |||||||
|
Diluted
|
.07 | (.22 | ) | (.18 | ) | (.37 | ) | |||||||||||
|
Weighted average shares of common stock
outstanding:
|
||||||||||||||||||
|
Basic
|
24,155,740 | 24,000,000 | 24,153,862 | 23,404,000 | ||||||||||||||
|
Diluted
|
25,287,911 | 24,000,000 | 24,153,862 | 23,404,000 | ||||||||||||||
The accompanying notes are an integral part of these condensed consolidated financial statements.
2
ENDOCARE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
| June 30, | December 31, | |||||||||
| 2003 | 2002 | |||||||||
| (Unaudited) | ||||||||||
| ASSETS | ||||||||||
|
Current assets:
|
||||||||||
|
Cash and cash equivalents
|
$ | 37,521,310 | $ | 18,177,825 | ||||||
|
Available-for-sale securities
|
— | 22,183,160 | ||||||||
|
Accounts receivable, net
|
4,988,664 | 4,604,576 | ||||||||
|
Inventories
|
3,067,852 | 3,455,973 | ||||||||
|
Prepaid expenses and other current assets
|
5,620,892 | 640,758 | ||||||||
|
Assets held for sale
|
1,343,692 | 3,800,517 | ||||||||
|
Total current assets
|
52,542,410 | 52,862,809 | ||||||||
|
Property and equipment, net
|
7,474,890 | 8,229,288 | ||||||||
|
Goodwill
|
17,538,224 | 17,538,224 | ||||||||
|
Intangibles, net
|
12,366,097 | 13,013,880 | ||||||||
|
Investments and other assets
|
2,243,621 | 983,754 | ||||||||
|
Total assets
|
$ | 92,165,242 | $ | 92,627,955 | ||||||
| LIABILITIES AND STOCKHOLDERS’ EQUITY | ||||||||||
|
Current liabilities:
|
||||||||||
|
Accounts payable
|
$ | 3,972,200 | $ | 2,932,439 | ||||||
|
Accrued compensation
|
3,522,760 | 2,816,320 | ||||||||
|
Other accrued liabilities
|
9,223,911 | 7,327,703 | ||||||||
|
Total current liabilities
|
16,718,871 | 13,076,462 | ||||||||
|
Minority interests
|
950,923 | 928,741 | ||||||||
|
Commitments and contingencies
|
||||||||||
|
Stockholders’ equity:
|
||||||||||
|
Preferred stock, $.001 par value;
1,000,000 shares authorized; none issued and outstanding
|
— | — | ||||||||
|
Common stock, $.001 par value;
50,000,000 shares authorized; 24,163,254 and 24,148,254
issued and outstanding at June 30, 2003 and
December 31, 2002, respectively
|
24,365 | 24,350 | ||||||||
|
Additional paid-in capital
|
170,087,578 | 169,935,487 | ||||||||
|
Accumulated deficit
|
(93,358,029 | ) | (88,931,583 | ) | ||||||
|
Receivable from stockholder
|
(85,792 | ) | (214,292 | ) | ||||||
|
Accumulated other comprehensive income, net of tax
|
— | 12,466 | ||||||||
|
Deferred compensation
|
(101,043 | ) | (132,045 | ) | ||||||
|
Treasury stock at cost, 201,200 shares
|
(2,071,631 | ) | (2,071,631 | ) | ||||||
|
Total stockholders’ equity
|
74,495,448 | 78,622,752 | ||||||||
|
Total liabilities and stockholders’ equity
|
$ | 92,165,242 | $ | 92,627,955 | ||||||
The accompanying notes are an integral part of these condensed consolidated financial statements.
3
ENDOCARE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
| Six Months Ended June 30, | ||||||||||
| 2003 | 2002 | |||||||||
| (Restated) | ||||||||||
|
Net cash used in operating activities:
|
$ | (7,856,753 | ) | $ | (9,483,683 | ) | ||||
|
Cash flows from investing activities:
|
||||||||||
|
Acquisitions, net of cash acquired
|
— | (12,754,000 | ) | |||||||
|
Earnest money deposit on acquisition of mobile
prostate treatment businesses
|
(900,000 | ) | ||||||||
|
Purchases of property and equipment
|
(440,165 | ) | (1,910,224 | ) | ||||||
|
Intangibles
|
(61,000 | ) | — | |||||||
|
Sales (purchases) of available-for-sale
securities
|
22,183,160 | (17,286,672 | ) | |||||||
|
Other assets
|
(1,259,867 | ) | (43 | ) | ||||||
|
Net cash provided by (used in) investing
activities
|
20,199,926 | (32,850,939 | ) | |||||||
|
Cash flows from financing activities:
|
||||||||||
|
Partnership distributions to minority interests
|
(222,202 | ) | — | |||||||
|
Stock options and warrants exercised
|
20,312 | 1,945,500 | ||||||||
|
Repurchase of treasury stock
|
— | (424,621 | ) | |||||||
|
Proceeds from divestitures
|
6,980,000 | — | ||||||||
|
Net cash provided by financing activities
|
7,000,312 | 1,520,879 | ||||||||
|
Net increase (decrease) in cash and cash
equivalents
|
19,343,485 | (40,813,743 | ) | |||||||
|
Cash and cash equivalents, beginning of period
|
18,177,825 | 81,886,801 | ||||||||
|
Cash and cash equivalents, end of period
|
$ | 37,521,310 | $ | 41,073,058 | ||||||
|
Non-cash activities:
|
||||||||||
|
Transfer of inventory to property and equipment
for placement at customer sites
|
$ | 594,387 | $ | 541,717 | ||||||
|
Common stock issued and options assumed in the
acquisition of TIMM
|
— | 25,741,128 | ||||||||
|
Common stock issued for patents and
covenant-not-to-compete
|
— | 3,257,139 | ||||||||
|
Change in unrealized gain on available-for-sale
securities
|
12,466 | 24,070 | ||||||||
The accompanying notes are an integral part of these condensed consolidated financial statements.
4
ENDOCARE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
| 1. | Organization and Operations of the Company |
Endocare, Inc. (“Endocare” or the “Company”) is a medical device company focused on developing, manufacturing and selling cryosurgical products with the potential to improve the treatment of cancer and other tumors. In addition, through its wholly-owned subsidiary, Timm Medical Technologies, Inc. (“Timm Medical”), the Company offers vacuum therapy systems for non-pharmaceutical treatment of erectile dysfunction. The Company was formed in 1990 as a research and development division of Medstone International, Inc., a manufacturer of shockwave lithotripsy equipment for the treatment of kidney stones The Company was incorporated under the laws of the state of Delaware in 1994 and became an independent, publicly-owned corporation upon Medstone’s distribution of the Company’s stock to the existing stockholders on January 1, 1996.
Following the rules and regulations of the Securities and Exchange Commission (the “SEC”), the Company has omitted footnote disclosures in this report that would substantially duplicate the disclosures contained in the Company’s annual audited financial statements. The accompanying unaudited condensed consolidated financial statements should be read together with the consolidated financial statements and the notes thereto included in the Company’s December 31, 2002 and 2003 Annual Report on Form 10-K, filed with the SEC on December 3, 2003 and March 15, 2004, respectively.
Additionally, the condensed consolidated financial statements for the quarter ended June 30, 2002 contained in this report reflect various restatement adjustments made as a result of a review by management of historical financial statements previously filed with the SEC, including the report filed for that period. For a further description of the nature and status of these adjustments see Note 6 below, “Item 2 — Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Note 3 to our consolidated financial statements contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2002 filed with the SEC on December 3, 2003.
The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles for interim financial information and reflect all adjustments, consisting solely of normal recurring accruals, needed to present fairly the financial results for these interim periods. The condensed consolidated results of operations presented for the interim periods are not necessarily indicative of the results for a full year.
All intercompany transactions and accounts have been eliminated in consolidation.
| 2. | Recent Operating Results and Liquidity |
The Company’s operating results for the six months ended June 30, 2003 reflect the impact of divestitures of certain non-core lines of business. While these divestitures have allowed the Company to better concentrate on its core businesses, they have also eliminated some sources of revenue and gross profit for the Company. In addition, while the Company lowered certain operating costs in 2003 by consolidating functions that were formerly performed by its subsidiaries into the Irvine California headquarters, the Company has also incurred significant one-time charges associated with ongoing investigations related to its historical accounting and financial reporting. These costs have amounted to approximately $20.2 million from the fourth quarter of 2002 through the first quarter of 2004 (including executive severance charges of $3.2 million in the third quarter of 2003). Of these costs, $3.5 million were incurred in the first two quarters of 2003. In addition to charges for executive severance payments, these non-recurring expenses have included legal fees and settlements, audit fees and accounting support fees.
Since inception, the Company has incurred losses from operations and has reported negative cash flows. As of June 30, 2003, the Company had an accumulated deficit of $93.4 million and cash and cash equivalents of $37.5 million. As discussed above, commencing in the fourth quarter of 2002, the Company has incurred, and continues to incur, significant additional costs in connection with internal and regulatory investigations
5
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
into its historical accounting and financial reporting and has continued to incur operating losses. The Company also faces potentially large costs related to directors’ and officers’ liability insurance, delinquent state and local tax obligations, as well as additional expenditures needed to bring the Company into compliance with SEC rules and regulations, including with Section 404 of the Sarbanes-Oxley Act of 2002 and efforts to regain listing on a national exchange or market.
There may also be material cash payments required in connection with resolving a class action and a derivative lawsuit (see Note 9). The Company may be required to pay judgments or settlements and to incur expenses in defending against these claims that could exceed the Company’s directors’ and officers’ liability insurance coverage. Regulators may fine the Company when the investigations are complete.
The Company has continued to experience growth in probe and procedure revenues during the remainder of 2003 and into the first quarter of 2004. Costs and expenses have also grown through this period. Management intends to continue investment in sales and marketing to increase market penetration and in research and development to improve existing products and develop new ones. The Company will continue to use cash reserves to finance its cash flow deficit. If the Company is unable to generate cash flows from operations, it may need to raise additional capital to fund operations through the sale of equity securities to public or private investors, debt or the sale or licensing of its assets. Additional capital, if needed, might not be available on terms acceptable to the Company, or at all. If additional capital were raised through the issuance of equity securities, the percentage of the Company’s stock owned by its then-current stockholders would be reduced.
The Company has no long-term debt and no other material financial commitments other than those under operating lease agreements and purchase commitments for raw materials used in manufacturing its products.
| 3. | Stock-Based Compensation |
At June 30, 2003, Endocare had four stock-based compensation plans. The Company accounts for the plans under the recognition and measurement principles (the intrinsic-value method) prescribed in Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations. Compensation cost for stock options granted to employees is reflected in net income (loss) and is measured as the excess of the market price of the Company’s stock at the date of grant over the amount an employee must pay to acquire the stock, or the exercise price. Compensation costs for fixed awards that are subject to vesting is recognized pro-rata over the vesting period. In practice, the Company has only awarded stock options to its employees with exercise prices equal to the fair market value of the stock at the date of grant.
6
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
The Company has adopted the disclosure provisions required by Statement of Financial Accounting Standard (SFAS) No. 148, Accounting for Stock-Based Compensation — Translation and Disclosure. The following table illustrates the effect on net loss and loss per share if the Company had applied the fair value recognition provisions to stock-based employee compensation.
| Three Months Ended June 30, | Six Months Ended June 30, | ||||||||||||||||
| 2003 | 2002 | 2003 | 2002 | ||||||||||||||
| (Restated) | (Restated) | ||||||||||||||||
|
Net income (loss), as reported(a)
|
$ | 1,661,452 | $ | (5,205,052 | ) | $ | (4,426,446 | ) | $ | (8,678,333 | ) | ||||||
|
Reconciling items (net of related tax effects):
|
|||||||||||||||||
|
Add: Stock-based employee compensation expense
determined under the intrinsic-value-based method for all
awards(b)
|
6,194 | 9,921 | 12,388 | 13,228 | |||||||||||||
|
Less: Stock-based compensation expense determined
under the fair-value-based method for all awards expense
|
(2,183,808 | ) | (882,583 | ) | (3,658,666 | ) | (1,626,791 | ) | |||||||||
|
Net adjustment
|
(2,177,614 | ) | (872,662 | ) | (3,646,278 | ) | (1,613,563 | ) | |||||||||
|
Net income (loss), as adjusted
|
(516,162 | ) | (6,077,714 | ) | (8,072,724 | ) | (10,291,896 | ) | |||||||||
|
Basic and diluted loss per share:
|
|||||||||||||||||
|
As reported
|
$ | .07 | $ | (.22 | ) | $ | (.18 | ) | $ | (.37 | ) | ||||||
|
As adjusted
|
$ | (.02 | ) | $ | (.25 | ) | $ | (.33 | ) | $ | (.44 | ) | |||||
| (a) | The Company issues stock options and warrants to consultants for services performed. Compensation expense for the fair value of these instruments is determined by the Black-Scholes option pricing model and is charged to operations over the service period or as the performance goals are achieved. Such expense is included in net income (loss) as reported. | |
| (b) | Since the Company issues options with exercise prices equal to or exceeding the fair values of the underlying common stock, no compensation expense is recorded for options issued to employees, except for compensation expense equal to the intrinsic value of unvested options assumed in the acquisition of Timm Medical and amortized over the remaining vesting period. |
| 4. | Available-for-Sale Securities |
The Company invested its idle cash in a diversified portfolio of marketable debt securities, which consisted of corporate bonds, government agencies securities and commercial paper. These securities were classified as available-for-sale in accordance with SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities. Fair values were based on quoted prices in active markets. Unrealized gains or losses, net of applicable income taxes, were recorded as a component of accumulated other comprehensive income in stockholders’ equity. These securities had fair values which approximated their carrying values and had contractual maturities from less than 1 year to over 10 years. During the second quarter of 2003, the investment portfolio was liquidated, resulting in an insignificant gain.
| 5. | Goodwill and Intangible Assets |
The excess of the purchase price over the fair value of net assets acquired has been allocated to goodwill and identifiable intangible assets. The Company had no reported goodwill prior to January 1, 2002. The Company does not amortize goodwill, which is consistent with the provisions of SFAS No. 142, Goodwill and other Intangible Assets, but goodwill is subject to impairment tests on an annual basis or more frequently if
7
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
impairment indicators exist. Under the guidance of SFAS No. 142, the Company uses a discounted cash flow methodology to assess the fair values of its reporting units. Impairment is measured by comparing the goodwill derived from the hypothetical purchase price allocation to the carrying value of the goodwill balance. During the fourth quarter of 2002, the Company recorded an impairment charge of $18 million to reduce the carrying value of goodwill acquired in the Timm Medical acquisition resulting from the termination or abandonment of three of the acquired distribution agreements for urological products following the acquisition. No goodwill impairment indicators existed for the six months ended June 30, 2003 and, as a result, interim impairment testing was not required.
Intangible assets that are deemed to have finite useful lives are recorded at cost and amortized using the straight-line method over their estimated useful lives. Estimated useful lives of such intangible assets are as follows: