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EX-32.1 - 090930_IMSC_FORM 10Q_EX 32.1 - SECURE POINT TECHNOLOGIES INC | imscform10q090930_ex32-1.htm |
EX-32.2 - 090930_IMSC_FORM 10Q_EX 32.2 - SECURE POINT TECHNOLOGIES INC | imscform10q090930_ex32-2.htm |
EX-31.2 - 090930_IMSC_FORM 10Q_EX 31.2 - SECURE POINT TECHNOLOGIES INC | imscform10q090930_ex31-2.htm |
EX-31.1 - 090930_IMSC_FORM 10Q_EX 31.1 - SECURE POINT TECHNOLOGIES INC | imscform10q090930_ex31-1.htm |
UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
Form
10-Q
(Mark
One)
x QUARTERLY
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
For the
quarterly period ended September 30,
2009
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: 001-14949
Implant
Sciences Corporation
(Exact
name of registrant as specified in our charter)
Massachusetts
(State
or other jurisdiction of
incorporation
or organization)
|
04-2837126
(I.R.S.
Employer Identification No.)
|
|
600
Research Drive, Wilmington, Massachusetts
(Address
of principal executive offices)
|
01887
(Zip
Code)
|
(978)
752-1700
(Registrant’s
telephone number, including area code)
(Former
name, former address and former fiscal year, if changed since last
report)
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 q
Indicate
by check mark whether the registrant has submitted electronically and posted on
our 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 x No q
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. (Check one):
q Large
Accelerated
Filer q Accelerated
Filer
q Non-accelerated
Filer x Smaller
reporting company
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act).Yes
q No
x
As of
November 12, 2009, there were 15,424,195 shares of the registrant’s Common Stock
outstanding.
TABLE
OF CONTENTS
Page
|
||
PART
I.
|
FINANCIAL
INFORMATION
|
|
Item
1.
|
Condensed
Consolidated Financial Statements (unaudited)
|
|
Condensed
Consolidated Balance Sheets at September 30, 2009 and June 30,
2009
|
3
|
|
Condensed
Consolidated Statements of Operations for the three months
ended
September
30, 2009 and 2008
|
4
|
|
Condensed
Consolidated Statements of Cash Flows for the three months
ended
September
30, 2009 and 2008
|
5
|
|
Notes
to Condensed Consolidated Financial Statements
|
6-24
|
|
Item
2.
|
Management’s
Discussion and Analysis of Financial Condition and Results of
Operations
|
25-37
|
Item
3.
|
Quantitative
and Qualitative Disclosures About Market Risk
|
37
|
Item
4T.
|
Controls
and Procedures
|
37-38
|
PART
II.
|
OTHER
INFORMATION
|
|
Item
1.
|
Legal
Proceedings
|
39
|
Item
1A.
|
Risk
Factors
|
39
|
Item
2.
|
Unregistered
Sales of Equity Securities and Use of Proceeds
|
40
|
Item
3.
|
Defaults
Upon Senior Securities
|
40
|
Item
4.
|
Submission
of Matters to a Vote of Security Holders
|
40
|
Item
5.
|
Other
Information
|
40
|
Item
6.
|
Exhibits
|
41
|
Signatures
|
42
|
-2-
Implant
Sciences Corporation
|
||||||||
Consolidated
Balance Sheets
|
||||||||
September
30,
|
June
30,
|
|||||||
2009
|
2009
|
|||||||
(Unaudited)
|
(Audited)
|
|||||||
ASSETS
|
||||||||
Current
assets:
|
||||||||
Cash
and cash equivalents
|
$ | 332,000 | $ | - | ||||
Restricted
cash
|
689,000 | 664,000 | ||||||
Accounts
receivable-trade, net of allowance of $68,000 and $65,000,
respectively
|
630,000 | 201,000 | ||||||
Accounts
receivable, unbilled
|
32,000 | 138,000 | ||||||
Note
receivable
|
169,000 | 167,000 | ||||||
Inventories
|
404,000 | 561,000 | ||||||
Prepaid
expenses and other current assets
|
366,000 | 518,000 | ||||||
Current
assets held for sale
|
106,000 | 169,000 | ||||||
Total
current assets
|
2,728,000 | 2,418,000 | ||||||
Property
and equipment, net
|
245,000 | 276,000 | ||||||
Note
receivable
|
719,000 | 766,000 | ||||||
Other
non-current assets
|
18,000 | 68,000 | ||||||
Goodwill
|
3,136,000 | 3,136,000 | ||||||
Total
assets
|
$ | 6,846,000 | $ | 6,664,000 | ||||
LIABILITIES
AND STOCKHOLDERS' (DEFICIT) EQUITY
|
||||||||
Current
liabilities:
|
||||||||
Cash
overdraft
|
$ | - | 6,000 | |||||
Senior
secured convertible note
|
5,195,000 | 4,049,000 | ||||||
Line
of credit
|
1,833,000 | - | ||||||
Current
maturities of long-term debt and obligations under capital
lease
|
25,000 | 27,000 | ||||||
Notes
payable
|
100,000 | 100,000 | ||||||
Payable
to Med-Tec
|
56,000 | 56,000 | ||||||
Accrued
expenses
|
1,940,000 | 1,968,000 | ||||||
Accounts
payable
|
3,294,000 | 4,337,000 | ||||||
Current
portion of long-term lease liability
|
362,000 | 334,000 | ||||||
Deferred
revenue
|
18,000 | 428,000 | ||||||
Current
liabilities held for sale
|
79,000 | 107,000 | ||||||
Total
current liabilities
|
12,902,000 | 11,412,000 | ||||||
Long-term
liabilities:
|
||||||||
Long-term
debt and obligations under capital lease, net of current
maturities
|
83,000 | 86,000 | ||||||
Long-term
lease liability
|
- | 84,000 | ||||||
Total
long-term liabilities
|
83,000 | 170,000 | ||||||
Total
liabilities
|
12,985,000 | 11,582,000 | ||||||
Commitments
and contingencies
|
||||||||
Series
E Convertible Preferred Stock, $5 stated value; 1,000,000
shares
|
||||||||
authorized,
1,000,000 shares outstanding (liquidation value
$5,000,000)
|
5,000,000 | 5,000,000 | ||||||
Series
F Convertible Preferred Stock, no stated value; 2,000,000
shares
|
||||||||
authorized,
1,646,063 shares outstanding (liquidation value $378,000)
|
378,000 | - | ||||||
Stockholders'
(deficit) equity:
|
||||||||
Common
stock; $0.10 par value; 50,000,000 shares authorized; 15,434,740
and
15,424,195
at September 30, 2009 and June 30, 2009 shares issued and outstanding,
respectively
|
1,543,000 | 1,543,000 | ||||||
Additional
paid-in capital
|
61,340,000 | 61,290,000 | ||||||
Accumulated
deficit
|
(74,327,000 | ) | (72,678,000 | ) | ||||
Treasury
stock, 10,545 common shares, respectively, at cost
|
(73,000 | ) | (73,000 | ) | ||||
Total
stockholders' (deficit) equity
|
(11,517,000 | ) | (9,918,000 | ) | ||||
Total
liabilities and stockholders' (deficit) equity
|
$ | 6,846,000 | $ | 6,664,000 | ||||
The
accompanying notes are an integral part of these financial
statements.
|
-3-
Implant
Sciences Corporation
|
||||||||
Consolidated
Statements of Operations
|
||||||||
(Unaudited)
|
||||||||
For
the Three Months Ended
|
||||||||
September
30,
|
||||||||
2009
|
2008
|
|||||||
Revenues:
|
||||||||
Security
products
|
$ | 1,635,000 | $ | 5,302,000 | ||||
Government
contracts and services
|
185,000 | 646,000 | ||||||
1,820,000 | 5,948,000 | |||||||
Cost
of revenues
|
979,000 | 3,172,000 | ||||||
Gross
margin
|
841,000 | 2,776,000 | ||||||
Operating
expenses:
|
||||||||
Research
and development
|
595,000 | 1,020,000 | ||||||
Selling,
general and administrative
|
1,227,000 | 2,366,000 | ||||||
1,822,000 | 3,386,000 | |||||||
Loss
from operations
|
(981,000 | ) | (610,000 | ) | ||||
Other
income (expense), net:
|
||||||||
Interest
income
|
18,000 | 8,000 | ||||||
Interest
expense
|
(666,000 | ) | (32,000 | ) | ||||
Total
other income (expense), net
|
(648,000 | ) | (24,000 | ) | ||||
Loss
from continuing operations
|
(1,629,000 | ) | (634,000 | ) | ||||
Preferred
distribution, dividends and accretion
|
- | (189,000 | ) | |||||
Loss
from continuing operations applicable to common
shareholders
|
(1,629,000 | ) | (823,000 | ) | ||||
Net
(loss) income from discontinued operations
|
(20,000 | ) | 990,000 | |||||
Net
(loss) income applicable to common shareholders
|
$ | (1,649,000 | ) | $ | 167,000 | |||
Net
(loss) income
|
$ | (1,649,000 | ) | $ | 356,000 | |||
Loss
per share from continuing operations, basic and diluted
|
$ | (0.11 | ) | $ | (0.05 | ) | ||
Loss
per share from continuing operations applicable to common
shareholders,
basic and diluted
|
$ | (0.11 | ) | $ | (0.06 | ) | ||
(Loss)
income per share from discontinued operations, basic and
diluted
|
$ | (0.00 | ) | $ | 0.07 | |||
|
||||||||
Net
(loss) income per share applicable to common shareholders, basic
and diluted
|
$ | (0.11 | ) | $ | 0.01 | |||
Net
(loss) income per share
|
$ | (0.11 | ) | $ | 0.03 | |||
Weighted
average shares used in computing net (loss) income per common share, basic
and diluted
|
15,424,195 | 13,468,489 |
The
accompanying notes are an integral part of these financial
statements.
-4-
Implant
Sciences Corporation
|
||||||||
Consolidated
Statements of Cash Flows
|
||||||||
(Unaudited)
|
||||||||
For
The Three Months Ended September 30,
|
||||||||
2009
|
2008
|
|||||||
Cash
flows from operating activities:
|
||||||||
Net
(loss) income
|
$ | (1,649,000 | ) | $ | 356,000 | |||
Less: Net
(loss) income from discontinued operations
|
(20,000 | ) | 990,000 | |||||
Loss
from continuing operations
|
(1,629,000 | ) | (634,000 | ) | ||||
Adjustments
to reconcile net loss from continuing operations to net cash
flows:
|
||||||||
Depreciation
and amortization
|
34,000 | 72,000 | ||||||
Bad
debt expense
|
3,000 | 1,000 | ||||||
Share-based
compensation expense
|
43,000 | 114,000 | ||||||
Non-cash
interest expense
|
484,000 | - | ||||||
Fair
value of warrants issued to non-employees
|
1,000 | (9,000 | ) | |||||
Warrant
accretion on debt
|
40,000 | 7,000 | ||||||
Changes
in assets and liabilities:
|
||||||||
Accounts
receivable
|
(326,000 | ) | (188,000 | ) | ||||
Inventories
|
157,000 | (198,000 | ) | |||||
Prepaid
expenses and other current assets
|
208,000 | 131,000 | ||||||
Cash
overdraft
|
(6,000 | ) | - | |||||
Accounts
payable
|
(1,100,000 | ) | 353,000 | |||||
Accrued
expenses
|
(28,000 | ) | 877,000 | |||||
Deferred
revenue
|
(410,000 | ) | 578,000 | |||||
Lease
liability
|
- | (131,000 | ) | |||||
Net
cash (used in) provided by operating activities of continuing
operations
|
(2,529,000 | ) | 973,000 | |||||
Net
cash provided by operating activities of discontinued
operations
|
16,000 | 223,000 | ||||||
Net
cash (used in) provided by operating activities
|
(2,513,000 | ) | 1,196,000 | |||||
Cash
flows from investing activities:
|
||||||||
Purchases
of property and equipment
|
(3,000 | ) | (14,000 | ) | ||||
Transfer
to restricted funds
|
(25,000 | ) | - | |||||
Proceeds
from the sale of assets of discontinued operations
|
- | 1,125,000 | ||||||
Payments
received on note receivable
|
45,000 | - | ||||||
Increase
in other non-current assets
|
- | (110,000 | ) | |||||
Net
cash provided by investing activities of continuing
operations
|
17,000 | 1,001,000 | ||||||
Net
cash used in investing activities of discontinued
operations
|
- | (18,000 | ) | |||||
Net
cash provided by investing activities
|
17,000 | 983,000 | ||||||
Cash
flows from financing activities:
|
||||||||
Proceeds
from common stock issued in connection with exerciseof stock
options and employee stock purchase plan
|
- | 24,000 | ||||||
Dividends
on Series D Convertible Preferred Stock
|
- | (34,000 | ) | |||||
Payments
on Series D Convertible Preferred Stock
|
- | (303,000 | ) | |||||
Proceeds
from the issuance of senior secured convertible debt
|
1,000,000 | - | ||||||
Principal
repayments of long-term debt and capital lease obligations
|
(5,000 | ) | (218,000 | ) | ||||
Net
borrowings (repayments) on line of credit
|
1,833,000 | (46,000 | ) | |||||
Net
cash provided by (used in) financing activities of continuing
operations
|
2,828,000 | (577,000 | ) | |||||
Net
cash used in discontinued operations
|
- | (1,000 | ) | |||||
Net
cash provided by (used in) financing activities
|
2,828,000 | (578,000 | ) | |||||
Net
change in cash and cash equivalents
|
332,000 | 1,601,000 | ||||||
Cash
and cash equivalents at beginning of period
|
- | 412,000 | ||||||
Cash
and cash equivalents at end of period
|
$ | 332,000 | $ | 2,013,000 |
The
accompanying notes are an integral part of these financial
statements.
-5-
IMPLANT
SCIENCES CORPORATION
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS
1.
|
Description
of Business
|
Implant
Sciences Corporation provides systems and sensors for the homeland security
market and related industries. We have developed and acquired
technologies using ion mobility spectrometry to develop a product line for use
in trace explosives detection. We currently market and sell our
existing trace explosives detector products while continuing to make significant
investments in developing the next generation of these products.
Acquisition
of Ion Metrics
In April
2008, we acquired all of the capital stock of Ion Metrics, Inc. Ion
Metrics was in the business of producing low-cost mass sensor systems for the
detection and analysis of chemical compounds such as explosives, chemical
warfare agents, narcotics, and toxic industrial chemicals for the homeland
defense, forensic, environmental, and safety/security markets. The transaction
was structured as a reorganization of Ion Metrics with and into our newly
formed, wholly-owned subsidiary. The total purchase price, including
$564,000 of assumed liabilities, was approximately $3,309,000. As
part of the transaction, we issued to the former stockholders of Ion Metrics
consideration consisting of 2,000,000 shares of our common stock, par value
$0.10 per share. The integration of the Ion Metrics technologies into our
Quantum SnifferTM
product line is expected to provide opportunities to introduce smaller,
lower-cost, and higher performance security solutions.
Sale
of Accurel
In May
2007, we sold substantially all of the assets of our Accurel Systems subsidiary
to Evans Analytical Group, LLC for approximately $12,705,000, including
$1,000,000 held by an escrow agent as security for certain representations and
warranties. In February 2008, Evans filed suit in the Superior Court
of the State of California, Santa Clara County, requesting rescission of the
asset purchase agreement, plus damages, based on claims of misrepresentation and
fraud. In March 2008, Evans filed a notice with the escrow agent
prohibiting release of any portion of the escrow to us pending resolution of the
lawsuit. In March 2009, we announced the settlement of this
litigation and the mutual release by us and Evans of all claims related to the
sale of Accurel. In settling this litigation, we agreed to pay Evans
damages in the amount of approximately $5,700,000 by (i) agreeing to release to
Evans approximately $700,000 that had been held in escrow since the time of the
closing of the Accurel sale and (ii) agreeing to issue to Evans 1,000,000 shares
of Series E Convertible Preferred Stock having an aggregate liquidation
preference of $5,000,000. In April 2009, $700,000 of the funds held
in escrow, together with accrued interest, was released to Evans and $300,000,
the balance of the escrow amount, was released to us.
Sale
of Core
In
November 2008, we entered into a definitive agreement, with Core Systems
Incorporated, an entity newly formed by the Subsidiary’s general manager and
certain other investors (the “Buyer”), to sell substantially all the assets of
our wholly owned semiconductor subsidiary, C Acquisition Corp., which had
operated under the name Core Systems (the “Subsidiary”), for a purchase price of
$3,000,000 plus the assumption of certain liabilities. The Buyer made
a cash down payment of $250,000 prior to the execution of the definitive
agreement. On November 24, 2008, the parties amended the agreement
and completed the asset sale. On that date, the Buyer made a cash
payment of $1,125,000 and issued a promissory note in the amount of
$1,625,000. The promissory note required the Buyer to pay the
Subsidiary $125,000 on or before November 28, 2008, an additional $500,000 on or
before December 24, 2008, and the remaining principal balance, together with
accrued interest, in equal monthly installments over a period of 60 months
commencing on February 1, 2009. The Buyer and the Subsidiary also
executed a security agreement, pursuant to which the Buyer granted the
Subsidiary a security interest in all of the Buyer’s assets to secure our
obligations under the promissory note. The Buyer paid $250,000 of the
amount due in December and paid the remaining $250,000 balance due in March
2009.
Sale
of Medical Reporting Unit
In June
2007, we sold certain of the assets related to our brachytherapy products and
divested the prostate seed and medical software businesses. In March
2008, we informed our medical coatings customers of our intention to discontinue
coating operations by the end of the 2008 calendar year. During the
three months ended September 30, 2008, under two separate asset purchase
agreements, we sold certain assets of our medical coatings business, with gross
proceeds aggregating approximately $1,145,000. The Medical Reporting
Unit is reported as discontinued operations in the accompanying financial
statements.
-6-
IMPLANT
SCIENCES CORPORATION
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS
CorNova
We had
partnered with CorNova, Inc., a privately-held, development stage company
focused on the development of a next-generation drug-eluting stent, and were
issued 1,500,000 shares of CorNova’s common stock representing a 15% ownership
interest. On December 10, 2008, we transferred the CorNova shares in
connection with the issuance of the senior secured convertible promissory note
(See Note 13).
|
Risks
and Uncertainties
|
Despite
our current sales, expense and cash flow projections and the cash available from
our line of credit with DMRJ Group LLC, we require additional capital in the
second quarter of fiscal 2010 to repay our senior secured convertible promissory
note and line of credit, both of which mature on December 10, 2009, fund
operations and continue the development, commercialization and marketing of our
products. Our failure to achieve our projections and/or obtain sufficient
additional capital on acceptable terms would have a material adverse effect on
our liquidity and operations and could require us to file for protection under
bankruptcy laws.
In
addition, while we strive to bring new products to market, we
are subject to a number of risks similar to the risks faced by other
technology-based companies, including risks related to: (a) our dependence on
key individuals and collaborative research partners; (b) competition from
substitute products and larger companies; (c) our ability to develop and market
commercially usable products and obtain regulatory approval for our products
under development; and (d) our ability to obtain substantial additional
financing necessary to adequately fund the development, commercialization and
marketing of our products. For the three months ended September 30,
2009, we reported a net loss applicable to common shareholders of $1,649,000, a
loss from continuing operations of $1,629,000 and used $2,513,000 in cash from
operations. As of September 30, 2009, we had an accumulated deficit
of approximately $74,327,000 and a working capital deficit of
$10,174,000. Management continually evaluates plans to reduce our
operating expenses and increase our cash flow from
operations. Failure to achieve our projections may require us to seek
additional financing or discontinue operations.
Based on
current sales, operating expense and cash flow projections, and the cash
available from our line of credit, management believes there are plans in place
to sustain operations for the next several months. These plans depend
on a substantial increase in sales of our handheld trace explosives detector
product. To further sustain us, improve our cash position, and enable
us to grow while reducing debt, management plans to seek additional capital
through private financing sources during the next three
months. However, there can be no assurance that management will be
successful in executing these plans. Management will continue to
closely monitor and attempt to control our costs and actively seek needed
capital through sales of our products, equity infusions, government grants and
awards, strategic alliances, and through our lending institutions.
We have
suffered recurring losses from operations. Our consolidated financial
statements have been presented on the basis that it is a going concern, which
contemplates the realization of assets and the satisfaction of liabilities in
the normal course of business.
There can
be no assurances that our forecasted results will be achieved or that we will be
able to raise additional capital necessary to operate our
business. These conditions raise substantial doubt about our ability
to continue as a going concern. The financial statements do not
include any adjustments relating to the recoverability and classification of
asset amounts or the amounts and classification of liabilities that might be
necessary should we be unable to continue as a going concern.
We have
experienced a reduction in security revenue in the three month period ended
September 30, 2009 as compared with the comparable prior year period, relating
to a decline in unit sales of our trace explosives products. Security product
sales tend to have a long sale cycle, and are often subject to export
controls. In an effort to identify new opportunities and stimulate
sales, we have implemented a new sales tool to assist in this
effort. However, there can be no assurance that these efforts will
increase revenue.
We have a
history of being active in submitting proposals for government sponsored grants
and contracts and successful in being awarded grants and contracts from
government agencies. However, we have experienced a decline in government
contract revenue in the three month period ended September 30, 2009 as compared
to the comparable prior year period, due to the expiration of several contracts
in the three month period ended September 30, 2009. Management will
continue to pursue these grants and contracts to support our research and
development efforts primarily in the areas of trace explosives
detection.
-7-
IMPLANT
SCIENCES CORPORATION
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS
In June,
August, October and November, we entered into a series of amendments, waivers
and modifications to our credit agreements with Bridge Bank, N.A., pursuant to
which, in exchange for the payment by us of forbearance fees in the amount of
$90,000, the bank waived certain existing and anticipated defaults, the bank
reduced our credit line to $1,500,000 from $5,000,000, and extended the modified
facility through December 10, 2008. On December 10, 2008, we used approximately
$477,000 of the proceeds of the sale of the senior secured convertible
promissory note (see Note 13) to repay all of the indebtedness outstanding to
the bank and the credit facility was terminated. As of September 30,
2009 and 2008, our obligation for borrowed funds under the credit facility
amounted to $0 and $718,000, respectively.
On
December 10, 2008, we entered into a note and warrant purchase agreement with
DMRJ Group LLC, an accredited institutional investor, pursuant to which we
issued a senior secured convertible promissory note in the principal amount of
$5,600,000 and a warrant to purchase 1,000,000 shares of our common
stock. The note bears interest at 11.0% per annum and is
collateralized by all of our assets. The effective interest rate on
the note is approximately 23.4%. We prepaid interest in the amount of
$616,000 upon the issuance of the note. In lieu of paying any
commitment fees, closing fees or other fees in connection with the purchase
agreement, we transferred our entire interest in 1,500,000 shares of the common
stock of CorNova Inc., a privately-held development stage medical device
company, to DMRJ. The note, which has been amended and
restated, as described below, was originally convertible in whole or
in part at the option of DMRJ into shares of our common stock at a conversion
price of $0.26 per share.
We valued
the note upon issuance at its residual value of $4,356,000 based on the
fair values of the financial instruments issued in connection with this
convertible debt financing, including the warrant, the original issue discount
and the fair value of the CorNova common stock transferred to
DMRJ. The amounts recorded in the financial statements represents the
amounts attributed to the senior secured convertible debt of $5,600,000, net of
$160,000 allocated to the warrant, $616,000 of original issue discount and
$468,000 representing the estimated fair value of the CorNova common
stock. The warrant was valued using the Black-Scholes model with the
following assumptions: volatility 98.4%, risk-free interest rate of
2.29%, expected life of five years and expected dividend yield of
0.00%. As required under the terms of the note, we made a principal
payment of $1,000,000 on December 24, 2008. The note required us to
make a principal payment in an amount equal to any funds released from the
escrow created in connection with the May 2007 sales of the assets of Accurel
Systems International, upon the release of such funds. DMRJ
waived that requirement in connection with the Evans litigation
settlement.
On March
12, 2009, we entered into a letter agreement with DMRJ pursuant to which we were
granted access to $250,000 of previously restricted cash out of funds held in a
blocked account. The effect of the letter agreement made $250,000
available to us until the close of business on April 14, 2009. In
consideration of the letter agreement, on March 12, 2009, we issued an amended
and restated senior secured convertible promissory note and amended and restated
warrant to DMRJ to purchase shares of common stock, which replaced the note and
warrant issued on December 10, 2008. The terms of the amended and
restated note and the amended and restated warrant are identical to the terms of
the original note and warrant, except that the amended instruments reduced the
initial conversion price of the original note from $0.26 to $0.18 and reduced
the initial exercise price of the original warrant from $0.26 to
$0.18.
The
remaining principal balance of the amended and restated note, together with
outstanding interest, is due and payable on December 10, 2009.
The note
contains restrictions and financial covenants including: (i) restrictions
against declaring or paying dividends or making any distributions; against
creating, assuming or incurring any liens; against creating, assuming
or incurring any indebtedness; against merging or consolidating with any other
company, provided, however, that a merger or consolidation is permitted if we
are the surviving entity; against the sale, assignment, transfer or lease of our
assets, other than in the ordinary course of business and excluding inventory
and certain asset sales expressly permitted by the note purchase agreement;
against making investments in any company, extending credit or loans, or
purchasing stock or other ownership interest of any company; and (ii) covenants
that we have authorized or reserved for the purpose of issuance, 150% of the
aggregate number of shares of our common stock issuable upon exercise
of the warrant that we maintain a minimum cash balance of at least
$500,000; that the aggregate dollar amount of all accounts payable be
no more than 100 days past due; and that we maintain a current ratio, defined as
current assets divided by current liabilities, of no less than 0.60 to
1.00. As
of September 30, 2009, our current ratio was 0.21 to 1.00, the aggregate dollar
amount of all of our accounts payable exceeded 100 days past due and the minimum
cash balance required to be maintained in the blocked account was less than the
required minimum of $500,000. As
-8-
IMPLANT
SCIENCES CORPORATION
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS
such, we
are not in compliance with the required current ratio and accounts payable
financial covenants and have not complied with the requirement to maintain a
minimum of $500,000 in the blocked account. We have requested a
waiver for these events of noncompliance. If we are unable to obtain
a waiver of such noncompliance, DMRJ may declare the entire unpaid principal
balance, together with all interest accrued thereon, plus fees and expenses, due
and payable. Any such action on the part of DMRJ would have a
material adverse effect on our liquidity and financial condition and could force
us to curtail or discontinue all of our operations and/or file for protection
under bankruptcy laws.
On July
1, 2009, we entered into an amendment to the December 10, 2008 note and warrant
purchase agreement with DMRJ, pursuant to which we issued a senior secured
promissory note to DMRJ in the principal amount of $1,000,000.
The note
bears interest at the rate of 2.5% per month. The principal balance of the note,
together with all outstanding interest and all other amounts owed under the
note, will be due and payable on the earlier of (i) December 10, 2009 and (ii)
the receipt by us of net proceeds of at least $3,000,000 from the issuance of
debt and/or equity securities in one or more transactions. In addition, at our
option, DMRJ may require us to prepay such amounts upon (i) certain
consolidations, mergers and business combinations involving us; (ii) the sale or
transfer of more than 50% of our assets, other than inventory sold in the
ordinary course of business, in one or more related or unrelated transactions;
or (iii) the issuance by us, in one or more related or unrelated transactions,
of any equity securities or securities convertible into equity securities (other
than options granted to employees and consultants pursuant to employee benefit
plans approved by our Board of Directors), which results in net cash proceeds to
us of more than $500,000; provided, however, that DMRJ
may not require us to prepay more than the net cash proceeds of any
transaction described in the preceding clause (iii) of this sentence. We may
prepay all or any portion of the principal amount of the note, without penalty
or premium, after prior notice to DMRJ.
The
amendment to the loan agreement provides that, in the event we have not obtained
net proceeds from the issuance of debt or equity securities upon terms and
conditions acceptable to DMRJ in its sole discretion of (i) $1,000,000 by
July 24, 2009 and (ii) to the extent that we satisfied such requirements, an
additional $2,000,000 by August 21, 2009, we will immediately engage in a sale
process satisfactory to DMRJ in its sole discretion by implementing a
contingency plan which may be established by DMRJ, including, without
limitation, the engagement at our expense of a third party investment banker
acceptable to DMRJ in its sole discretion. We did not satisfy these
requirements and in August 2009, we engaged Pickwick Capital Partners to market
the Company for sale.
In
connection with the additional note issued on July 1, 2009, we also issued
871,763 shares of our Series F Convertible Preferred Stock to DMRJ, and agreed
that, if we were unable to obtain net proceeds of at least $3,000,000 from the
issuance of debt and/or equity securities by August 31, 2009, we would issue
774,900 additional shares of Series F Preferred Stock to DMRJ. DMRJ later
extended this deadline until October 1, 2009. We did not satisfy this
requirement and, on October 1, 2009, we issued such additional shares to DMRJ.
All of the 1,646,663
shares of Series F Preferred Stock held by DMRJ are convertible into 25%
of our common stock, calculated on a fully diluted basis. In addition, for so
long as the note or the amended and restated senior secured convertible
promissory note issued to DMRJ as of December 10, 2008 remain outstanding, we
may not issue additional shares of common stock, or other securities convertible
into or exercisable for common stock, if such securities would increase the
number of shares of our common stock, calculated on a fully diluted basis, unless we simultaneously
issue to DMRJ that number of additional shares of Series F Preferred Stock which
is necessary to result in the number of shares of common stock into which the
Series F Preferred Stock held by DMRJ may be converted representing the same
percentage ownership of us on a fully diluted basis after such issuance as
immediately prior thereto.
After the
repayment in full of the promissory notes, described above, the number of shares
of common stock into which the Series F Preferred Stock is convertible will
remain subject to “full ratchet” antidilution protection in the event that we
issue additional shares of common stock (or securities convertible into or
exercisable for additional shares of Common Stock) at a price below $.08 per
share. “Full ratchet” antidilution protection completely protects an investor’s
investment from subsequent price erosion until the occurrence of a liquidity
event. The anti-dilution protection will not apply, however, to issuances of
stock and options to our employees, directors, consultants and advisors pursuant
to any equity compensation plan approved by our stockholders.
-9-
IMPLANT
SCIENCES CORPORATION
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS
The
Series F Preferred Stock is entitled to participate on an “as converted” basis
in all dividends or distributions declared or paid on our common stock. In the
event of any liquidation, dissolution or winding up of our Company, the holders
of the Series F Preferred Stock will be entitled to be paid an amount equal to
$.08 per share of Series F Preferred Stock, plus any declared but unpaid
dividends, prior to the payment of any amounts to the holders of our Series E
Convertible Preferred Stock or common stock by reason of their ownership of such
stock.
The
holders of the Series F Preferred Stock have no voting rights except as required
by applicable law. However, without the consent of the holders of a majority of
the Series F Preferred Stock, we may not (i) amend, alter or repeal any
provision of our Amended and Restated Articles of Organization or By-laws in a
manner that adversely affects the powers, preferences or rights of the Series F
Preferred Stock; (ii) authorize or issue any equity securities (or any equity or
debt securities convertible into equity securities) ranking prior and superior
to the Series F Preferred Stock with respect to dividends, distributions,
redemption rights or rights upon liquidation, dissolution or winding up; or
(iii) consummate any capital reorganization or reclassification of any of our
equity securities (or debt securities convertible into equity securities) into
equity securities ranking prior and superior to the Series F Preferred Stock
with respect to dividends, distributions, redemption rights or rights upon
liquidation, dissolution or winding up.
On August
5, 2009, we entered into a second amendment to the December 10, 2008 note and
warrant purchase agreement with DMRJ, pursuant to which we issued DMRJ
a bridge note in the principal amount of $700,000. The note
bears interest at the rate of 25% per annum. The principal balance of the note,
together with all outstanding interest and all other amounts owed under the
note, was due and payable on August 17, 2009. The outstanding
principal balance and interest due under this bridge note was paid on September
4, 2009.
On
September 4, 2009, we entered into an additional credit agreement with DMRJ,
pursuant to which DMRJ provided us with a revolving line of credit in the
maximum principal amount of $3,000,000. In connection with the credit agreement,
we issued a promissory note to DMRJ evidencing our obligations under the credit
facility. Each of our subsidiaries guaranteed our obligations under the credit
facility. Our obligations and our subsidiaries' obligations are secured by
grants of first priority security interests in all of our respective assets. In
addition, we agreed to cause all of our receivables and collections to be
deposited in a bank deposit account pledged to DMRJ pursuant to a blocked
account agreement. All funds deposited in the blocked collections account will
be applied towards the repayment of our obligations to DMRJ under the note.
Until the note and all of our obligations thereunder have been paid and
satisfied in full, we will have no right to access or make withdrawals from the
blocked account without DMRJ’s consent.
The note
bears interest at the rate of 25% per annum. Interest under the note will be due
on the first day of each calendar month. The principal balance of the note,
together with all outstanding interest and all other amounts owed under the
note, will be due and payable on December 10, 2009. We may prepay all or any
portion of the principal amount of the note, without penalty or premium, after
prior notice to DMRJ. Subject to applicable cure periods, amounts due under the
note are subject to acceleration upon certain events of default, including: (i)
any failure to pay when due any amount owed under the note; (ii) any failure to
observe or perform any other condition, covenant or agreement contained in the
note or certain conditions, covenants or agreements contained in the credit
agreement; (iii) certain suspensions of the listing or trading of our common
stock; (iv) a determination that any misrepresentation made by us to DMRJ
in the credit agreement or in any of the agreements delivered to DMRJ in
connection with the credit agreement were false or incorrect in any material
respect when made; (v) certain defaults under agreements related to any of our
other indebtedness; (vi) the institution of certain bankruptcy and insolvency
proceedings by or against us; (vii) the entry of certain monetary judgments
against us that are not dismissed or discharged within a period of 20 days;
(viii) certain cessations of our business in the ordinary course; (ix) the
seizure of any material portion of our assets by any governmental authority; and
(x) our indictment for any criminal activity.
In lieu
of paying DMRJ any commitment fees, closing fees or other fees in connection
with the credit agreement, we agreed to pay DMRJ an additional amount equal to
50% of or aggregate net profits, as defined, generated between the closing date
through the termination of the credit facility. Such payments will be due and
payable as earned upon (i) each request for an advance under the note, and (ii)
the termination of the credit facility. For the period September 4,
2009 through September 30, 2009, we experienced a net loss and
no such payments were due and payable to DMRJ as of September 30,
2009.
-10-
IMPLANT
SCIENCES CORPORATION
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS
Upon the
closing of the credit facility, we requested and were granted an initial advance
of approximately $1,633,000, of which we used approximately $715,000 to repay
all of our outstanding indebtedness to DMRJ pursuant to the bridge note
issued to DMRJ on August 5, 2009, and approximately $548,000 to retire certain
obligations owed to other parties. We used the balance of the initial
advance for working capital and ordinary course general corporate
purposes.
As
of September 30, 2009, our obligations to DMRJ under the amended and restated
senior secured promissory note, the second senior secured promissory note and
under the credit facility approximated $4,600,000, $1,000,000 and $1,833,000,
respectively. Further, as of September 30, 2009, our obligation to
DMRJ for accrued interest under the amended senior secured promissory note and
under the credit facility approximated $108,000. All such amounts are due and
payable on December 10, 2009. The failure to refinance this indebtedness or
otherwise negotiate extensions of our obligations to DMRJ would have a material
adverse impact on our liquidity and financial condition and could force us to
curtail or discontinue operations entirely
and/or file for protection under bankruptcy laws.
We are
currently expending significant resources to develop the next generation of our
current products and to develop new products. Although we continue to
fund as much research and development as possible through government grants and
contracts in accordance with the provisions of the respective grant awards, we
will require additional funding in order to continue the advancement of the
commercial development and manufacturing of the explosives detection
system. We will attempt to obtain such financing by: (i) government
grants, (ii) private financing, or (iii) strategic
partnerships. However, there can be no assurance that we will be
successful in our attempts to raise such additional financing.
We require
substantial funds for further research and development, regulatory approvals,
and the marketing of our explosives detection products. Our capital
requirements depend on numerous factors, including but not limited to the
progress of our research and development programs; the cost of filing,
prosecuting, defending and enforcing any intellectual property rights; competing
technological and market developments; changes in our development of
commercialization activities and arrangements; the hiring of additional
personnel, and acquiring capital equipment.
Under our
agreements with Laurus Master Fund, Ltd. we were required to redeem our
Series D Cumulative Redeemable Convertible Preferred Stock on a monthly basis,
with the final redemption payment to be made in September 2008. We
received a waiver of the monthly redemption payments for the period December
2006 through August 2007 and, in September 2007, we resumed making monthly
redemptions. In September, 2008, Laurus agreed to extend the final
redemption date to October 24, 2008 in exchange for a redemption payment of
$250,000, including $22,000 of accrued dividends. We did not meet our
redemption obligation on October 24, 2008 and, on November 4,
2008, we amended our agreements with Laurus, effective as of
October 31, 2008, to provide that the amount necessary to redeem in full the
Series D Preferred Stock would be increased to $2,461,000, together
with accrued and unpaid dividends. Under these amendments, we agreed
to make monthly redemption payments through a new final redemption date of April
10, 2009. We redeemed $268,000 of the $518,000 of Series D Preferred
Stock required to be redeemed as of the October 31, 2008 redemption date by
agreeing to issue 929,535 shares of our common stock, and redeemed the balance
with a cash payment of $250,000. On December 10, 2008, we used
approximately $1,161,000 of the proceeds of the sale of the senior secured
convertible promissory note (see Note 13) to redeem in full all of our
outstanding Series D Preferred Stock. In May 2009, we issued 929,535
shares of our common stock to an affiliate of Laurus completing the redemption
of the Preferred Series D. As
of September 30, 2009 and 2008, our obligation to redeem the Series D Preferred
Stock amounted to $0 and $2,121,000, respectively.
-11-
IMPLANT
SCIENCES CORPORATION
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS
2.
|
Interim
Financial Statements and Basis of
Presentation
|
The
accompanying condensed consolidated financial statements of we have been
prepared in accordance with U.S. generally accepted accounting principles (“U.S.
GAAP”). In the opinion of management, the accompanying condensed
consolidated financial statements include all adjustments (consisting only of
normal recurring adjustments), which we considers necessary for a fair
presentation of the financial position at such date and of the operating results
and cash flows for the periods presented. All intercompany balances
and transactions have been eliminated in consolidation. The results of
operations and cash flows for the three months ended September 30, 2009 may not
necessarily be indicative of results that may be expected for any succeeding
quarter or for the entire fiscal year. The information contained in
this Form 10-Q should be read in conjunction with our audited financial
statements, included in our Form 10-K, as amended, as of and for the year ended
June 30, 2009.
The
balance sheet at June 30, 2009 has been derived from our audited consolidated
financial statements at that date, but does not include all of the information
and footnotes required by U.S. GAAP for complete financial
statements.
The
accompanying condensed consolidated financial statements include our operations
in Massachusetts and California.
As a
result of our decision to dispose of Core, the operating results of Core are
presented in the accompanying condensed consolidated statements of operations as
discontinued operations for the three months ended September 30,
2008.
As a
result of our decision to dispose of the medical business unit, the assets and
liabilities of the medical business unit are presented in the accompanying
condensed consolidated balance sheet as assets and liabilities held for sale as
of September 30, 2009 and June 30, 2009, and the operating results of the
medical business unit are presented in the accompanying condensed consolidated
statements of operations as discontinued operations for the three months ended
September 30, 2009 and 2008.
Additionally,
the following notes to the condensed consolidated financial statements include
disclosures related to our continuing operations unless specifically identified
as disclosures related to discontinued operations.
Significant
accounting policies are described in Note 2 to the financial statements included
in Item 7 of our Form 10-K, as amended, as of June 30, 2009. The
preparation of financial statements in conformity with U.S. GAAP requires
management to make estimates and judgments, which are evaluated on an ongoing
basis, that affect the amounts reported in our condensed consolidated financial
statements and accompanying notes. Management bases our estimates on
historical experience and on various other assumptions that it believes are
reasonable under the circumstances, the results of which form the basis for
making judgments about the carrying values of assets and liabilities and the
amounts of revenues and expenses that are not readily apparent from other
sources. Actual results could differ from those estimates and
judgments. In particular, significant estimates and judgments include
those related to revenue recognition, allowance for doubtful accounts, useful
lives of property and equipment, inventory reserves, valuation for goodwill and
acquired intangible assets, and realization of amounts held in
escrow.
Certain
reclassifications were made to the financial statements for the three months
ended September 30, 2008 to conform to the presentation for the three
months ended September 30, 2009.
We have
evaluated subsequent events after the balance sheet date through the date of
filing of these financial statements with the SEC on November 13, 2009, for
appropriate accounting and disclosure.
3.
|
Fair
Value Measurement
|
The three
level fair value hierarchy to classify the inputs used in measuring fair value
are as follows:
Level 1
inputs to the valuation methodology are based on quoted prices (unadjusted) in
active markets for identical assets or liabilities;
Level 2
inputs to the valuation methodology are based are inputs other than quoted
prices included within Level 1 that are observable for the asset or liability,
either directly or indirectly; and
Level 3
inputs to the valuation methodology are based on unobservable inputs that
reflect our own assumptions about the assumptions market participants would use
in pricing the asset or liability.
-12-
IMPLANT
SCIENCES CORPORATION
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS
Financial
assets and liabilities are classified in their entirety based on the lowest
level of input that is significant to the fair value
measurement.
Our
financial instruments at September 30, 2009 include cash equivalents, restricted
cash, accounts receivable, note receivable, accounts payable and senior secured
convertible promissory note. The carrying amounts of cash and cash equivalents,
restricted cash, receivables and accounts payable are representative of their
respective fair values because of the short-term maturities or expected
settlement dates of these instruments. The fair value of debt, as included in
Note 13, is based on the fair value of similar instruments.
4.
|
Restricted
Cash
|
As
of September 30, 2009 and June 30, 2009, we had restricted cash of
$689,000 and $664,000, respectively. and consisted of the
following:
September
30,
|
June
30,
|
|||||||
2009
|
2009
|
|||||||
Money
market account
|
$ | 439,000 | $ | 439,000 | ||||
Blocked
account deposit
|
250,000 | 225,000 | ||||||
$ | 689,000 | $ | 664,000 |
The
restricted cash of $439,000 held in a money market account collateralizes our
performance under an irrevocable letter of credit issued on June 25, 2008, in
the amount of $418,000. The letter of credit provides performance
security equal to 10% of the contract amount for security product which shipped
in the first quarter of fiscal 2009. Pursuant to our agreement with
DMRJ (See Note 13), we are required to maintain a balance of at least $500,000
in a bank deposit account pledged to DMRJ pursuant to a blocked account
agreement. On December 16, 2008, we deposited $500,000
into a bank account pursuant to the blocked account agreement. On
March 12, 2009, we and DMRJ entered into a letter agreement to which DMRJ
consented to grant us access to $250,000 out of the funds held in the
blocked account for a period commencing on March 12, 2009 through, but not
including, April 15, 2009 at which date we are required to maintain a
minimum balance of not less that $500,000 in the blocked account. On
June 24, 2009, DMRJ consented to grant us access to an additional $25,000,
which was repaid on July 8, 2009. On July 16, 2009, DMRJ consented to
the reduction in the minimum balance required to be maintained in the blocked
account through September 3, 2009, after which time we were required to
maintain a minimum balance of at least $500,000 in the blocked
account. As of September 30, 2009, $250,000 was on deposit in the
blocked account, as such we are not in compliance with the required minimum cash
balance and have requested a waiver for this event of
noncompliance.
5.
|
Stock
Based Compensation
|
Our
condensed consolidated statements of operations for the three months ended
September 30, 2009 and 2008 include $43,000 and $114,000, respectively, of
compensation costs and no income tax benefit related to our stock-based
compensation arrangements for employee and non-employee director
awards. As of September 30, 2009, the total amount of unrecognized
stock-based compensation expense was approximately $254,000, which will be
recognized over a weighted average period of 1.85 years.
As of
September 30, 2009, there were options outstanding to purchase 3,412,788 shares
of our common stock at exercise prices ranging from $0.08 to
$10.00.
6.
|
Related
Party Transactions
|
The
former chairman of Ion Metrics, Inc., which we acquired in April 2008, serves as
a Managing Director of a merger and acquisition and management advisory firm
that we previously engaged to market our wholly-owned subsidiary, Core Systems,
and to assist with our efforts to acquire additional capital. During
the three months ended September 30, 2009 and 2008, this advisory firm was paid
$0 and $30,000, respectively. As of September 30, 2009, our
obligation to the advisory firm was $0. Further, we have entered into a fixed
asset lease agreement with Ferran Scientific, Inc., a firm owned by the father
of the former Ion Metrics chairman.
-13-
IMPLANT
SCIENCES CORPORATION
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS
Robert
Liscouski, a member of our Board of Directors, serves as the lead of strategic
and business development programs at Secure Strategy Group, a homeland
security-focused banking and strategic advisory firm that has been retained
by us to assist with our efforts to acquire additional
capital. During the three months ended September 30, 2009 and 2008,
this advisory firm was paid $63,000 and $0, respectively. As of
September 30, 2009, our obligation to the advisory firm was $0.
On June
4, 2009, Michael Turmelle, a member of our Board of Directors loaned $100,000 to
us (see Note 7).
7.
|
Notes
Payable
|
On June
4, 2009, Michael Turmelle, a member of our Board of Directors, loaned $100,000
to us. The loan bears interest at 10% and is
unsecured. The principal amount of the loan will be converted into
preferred stock or any other equity securities upon the next completed equity
financing. As of both September 30, 2009 and June 30, 2009, our
obligation under the note for borrowed funds amounted to $100,000. As
of September 30, 2009, our obligation to Mr. Turmelle for accrued interest
approximated $3,000.
8.
|
Goodwill,
Other Intangibles and Long-Lived
Assets
|
In April
10, 2008, we acquired all of the capital stock of Ion Metrics, Inc., located in
San Diego, California. The transaction was structured as a
reorganization of Ion Metrics with and into our newly formed, wholly-owned
subsidiary. The aggregate purchase price of Ion Metrics was
$3,309,000.
The
following table summarizes the purchase price allocation to the fair value of
the assets at the date of acquisition:
Accounts
receivable
|
$ | 7,000 | ||
Other
receivables
|
3,000 | |||
Prepaid
expenses
|
11,000 | |||
Property,
plant and equipment
|
83,000 | |||
Goodwill
|
3,136,000 | |||
Customer
relationships
|
69,000 | |||
$ | 3,309,000 |
The
acquisition of Ion Metrics resulted in goodwill of $3,136,000 and the
identification of $69,000 of intangible assets with finite
lives. Goodwill represents the excess of cost over the fair value of
tangible and identifiable assets of acquired companies. Goodwill and
intangible assets with indefinite lives are not amortized, but rather are
measured for impairment at least annually or whenever events indicate that there
may be an impairment. An impairment loss would be recognized if the
fair value of the long-lived assets is less than their carrying
value.
We have
selected June 30th of
each year as the date we perform our annual assessment to determine if goodwill
is impaired. We completed our annual assessment at June 30, 2009 and determined
there was no impairment of goodwill and no event indicating an impairment has
occurred subsequent to June 30, 2009. At September 30, 2009 and
June 30, 2009, we had goodwill of $3,136,000.
Intangible
assets with finite lives are valued according to the future cash flows they are
estimated to produce. These assigned values are amortized over the
period of time those cash flows are estimated to be produced. We
evaluate whether events or circumstances have occurred that indicate that the
estimated remaining useful life or the carrying value of these assets has been
impaired.
Our
intangible assets are being amortized over a period of twelve months, the
estimated useful lives of the assets, from the date of acquisition, April 10,
2008. Amortization expense for the three months ended September 30,
2009 and 2008 was $0 and $18,000, respectively.
-14-
IMPLANT
SCIENCES CORPORATION
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS
9.
|
Inventories
|
We value
our inventories at lower of cost or market. Cost is determined by the
first-in, first-out (FIFO) method, including material, labor and factory
overhead.
Inventories
consist of the following:
September
30,
|
June
30,
|
|||||||
2009
|
2009
|
|||||||
Raw
materials
|
$ | 199,000 | $ | 162,000 | ||||
Work
in progress
|
13,000 | 20,000 | ||||||
Finished
goods
|
192,000 | 379,000 | ||||||
Total
inventories
|
$ | 404,000 | $ | 561,000 |
10.
|
Property
and Equipment
|
Property
and equipment consist of the following:
September
30,
|
June
30,
|
|||||||
2009
|
2009
|
|||||||
Machinery
and equipment
|
$ | 221,000 | $ | 221,000 | ||||
Computers
and software
|
353,000 | 353,000 | ||||||
Furniture
and fixtures
|
8,000 | 8,000 | ||||||
Leasehold
improvements
|
75,000 | 72,000 | ||||||
Equipment
under capital lease
|
61,000 | 61,000 | ||||||
718,000 | 715,000 | |||||||
Less: accumulated
depreciation and amortization
|
473,000 | 439,000 | ||||||
$ | 245,000 | $ | 276,000 |
For the
three months ended September 30, 2009 and 2008, depreciation expense was $34,000
and $54,000, respectively.
11.
|
Accrued
Expenses
|
Accrued
expenses consist of the following:
September
30,
|
June
30,
|
|||||||
2009
|
2009
|
|||||||
Accrued
compensation and benefits
|
$ | 696,000 | $ | 731,000 | ||||
Accrued
taxes
|
486,000 | 479,000 | ||||||
Accrued
legal and accounting
|
167,000 | 257,000 | ||||||
Accrued
interest
|
124,000 | 9,000 | ||||||
Accrued
warranty costs
|
180,000 | 196,000 | ||||||
Other
accrued liabilities
|
287,000 | 296,000 | ||||||
$ | 1,940,000 | $ | 1,968,000 |
12.
|
Earnings
Per Share
|
Basic
earnings per share is computed by dividing net income (loss) by the weighted
average number of common shares outstanding during the
period. Diluted earnings per share are based upon the weighted
average number of common shares outstanding during the period plus additional
weighted average common equivalent shares outstanding during the
period. Common equivalent shares result from the assumed exercise of
outstanding stock options and warrants, the proceeds of which are then assumed
to have been used to repurchase outstanding common stock using the treasury
stock method. In addition, the numerator is adjusted for any changes
in income or loss that
-15-
IMPLANT
SCIENCES CORPORATION
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
would
result from the assumed conversion of potential shares. As of September 30, 2009
and 2008, there were no potentially dilutive shares, which shares would have
been excluded from the earnings per share calculation because their effect would
be antidilutive. Shares deemed to be antidilutive include stock options and
warrants.
13.
|
Long-Term
Debt and Credit Arrangements
|
Med-Tec
Payment Obligation
In July
2003, we entered into an asset purchase agreement with Med-Tec Iowa, Inc
(“Med-Tec”) our former exclusive distributor of prostate seeds, to purchase
Med-Tec’s customer lists and further to release each other from further
obligations under an earlier distribution agreement. The purchase
price of $1,250,000 which was payable in varying amounts over 28 months, with
the final payment payable on December 1, 2005, was recorded at the present value
of the future payment stream, using a rate of 10.24%, which equaled
$1,007,000. This amount was recorded as an intangible asset and was
amortized over our estimated useful life of 29 months. The
outstanding and past due principal balance as of September 30, 2009 and June 30,
2009 was approximately $56,000.
Revolving
Credit Facility and Term Note
In June
2005, we executed a revolving credit facility for $1,500,000 with Silicon
Valley-based Bridge Bank, N.A. On January 3, 2007, the revolving
credit facility was increased from $1,500,000 to $5,000,000. In June,
August, October and November, we entered into a series of further amendments,
waivers and modifications to our credit agreements with Bridge Bank, pursuant to
which, in exchange for the payment by us of forbearance fees in the amount
of $90,000, the bank waived certain existing and anticipated defaults, the bank
reduced our credit line to $1,500,000 from $5,000,000, and the bank extended the
modified facility through December 10, 2008. On December 10, 2008, we
used approximately $477,000 of the proceeds of the sale of the senior secured
convertible promissory note to DMRJ to repay all of the indebtedness outstanding
to the bank and the credit facility was terminated. As of September
30, 2009 and June 30, 2009, our obligation for borrowed funds under the credit
facility amounted to $0.
Pursuant
to the original loan agreement with Bridge Bank, we issued a seven-year warrant
to purchase 18,939 shares of our common stock at a price of $2.64 per
share. The warrant, valued using the Black-Scholes model, was
recorded at the relative fair value of $28,000 and accreted to the term note
over the life of the note. As of September 30, 2009, approximately
$28,000 has been amortized. Pursuant to an amendment to the loan
agreement, we issued to the Bank a seven-year warrant to purchase up to 43,860
additional shares of our common stock at a price equal to $1.14 per
share. The warrant, valued using the Black-Scholes model, was
recorded at the relative fair value of $29,000 and was charged to interest
expense during the year ended June 30, 2008.
Senior
Secured Convertible Promissory Note and Revolving Credit Facility
On
December 10, 2008, we entered into a note and warrant purchase agreement with
DMRJ Group LLC, an accredited institutional investor, pursuant to which we
issued a senior secured convertible promissory note in the principal amount of
$5,600,000 and a warrant to purchase 1,000,000 shares of our common
stock. The note bears interest at 11.0% per annum and is
collateralized by all of our assets. The effective interest rate on
the note is approximately 23.4%. We prepaid interest in the amount of
$616,000 upon the issuance of the note. In lieu of paying any
commitment fees, closing fees or other fees in connection with the purchase
agreement, we transferred our entire interest in 1,500,000 share of the common
stock of CorNova, Inc., a privately-held development stage medical device
company, to DMRJ. The note, which has been amended and restated,
as described below, was originally convertible in whole or in part at the
option of DMRJ into shares of our common stock at a conversion price of $0.26
per share.
We valued
the note upon issuance at its residual value of $4,356,000 based on the fair
values of the financial instruments issued in connection with this convertible
debt financing, including the warrant, the original issue discount and the fair
value of the CorNova common stock transferred to DMRJ Group LLC. The
amounts recorded in the financial statements represents the amounts attributed
to the senior secured convertible debt of $5,600,000, net of $160,000 allocated
to the warrant, $616,000 of original issue discount and $468,000 representing
the estimated fair value of the CorNova common stock. The warrant was
valued using the Black-Scholes model with the following
assumptions: volatility 98.4%, risk-free interest rate of 2.29%,
expected life of five years and expected dividend yield of 0.00%. As
required under the terms of the note, we made a principal payment of $1,000,000
on December 24, 2008. The note required us to make a principal
payment in an amount equal to any funds released from the
-16-
IMPLANT
SCIENCES CORPORATION
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
escrow
created in connection with the May 2007 sales of the assets of Accurel Systems
International, upon the release of such funds. DMRJ waived that requirement in
connection with the Evans litigation settlement.
On March
12, 2009, we entered into a letter agreement with DMRJ pursuant to which we were
granted access to $250,000 of previously restricted cash out of funds held in a
blocked account. The effect of the letter agreement made $250,000
available to us until the close of business on April 14, 2009. In
consideration of the letter agreement, on March 12, 2009, we issued an amended
and restated senior secured convertible promissory note and amended and restated
warrant to DMRJ to purchase shares of common stock, which replaced the note and
warrant issued on December 10, 2008. The terms of the amended and
restated note and the amended and restated warrant are identical to the terms of
the original note and warrant, except that the amended instruments reduced the
initial conversion price of the original note from $0.26 to $0.18 and reduced
the initial exercise price of the original warrant from $0.26 to
$0.18.
The
remaining principal balance of the amended and restated note, together with
outstanding interest, is due and payable on December 10, 2009.
The note
contains restrictions and financial covenants including: (i) restrictions
against declaring or paying dividends or making any distributions; against
creating, assuming or incurring any liens; against creating, assuming
or incurring any indebtedness; against merging or consolidating with any other
company, provided, however, that a merger or consolidation is permitted if
we are the surviving entity; against the sale, assignment, transfer or
lease of our assets, other than in the ordinary course of business and excluding
inventory and certain asset sales expressly permitted by the note purchase
agreement; against making investments in any company, extending credit or loans,
or purchasing stock or other ownership interest of any company; and (ii)
covenants that we have authorized or reserved for the purpose of
issuance, 150% of the aggregate number of shares of our common
stock issuable upon exercise of the warrant; that we maintain a
minimum cash balance of at least $500,000; that the aggregate dollar amount
of all accounts payable be no more than 100 days past due; and that we
maintain a current ratio, defined as current assets divided by current
liabilities, of no less than 0.60 to 1.00. As
of September 30, 2009, our current ratio was 0.21 to 1.00, the aggregate dollar
amount of all of our accounts payable exceeded 100 days past due and the minimum
cash balance required to be maintained in the blocked account was less than the
required minimum of $500,000. As such, we are not in compliance
with the required current ratio and accounts payable financial covenants and
have not complied with the requirement to maintain a minimum of $500,000 in
the blocked account. We have requested a waiver for these events of
noncompliance. If we are unable to obtain a waiver of such
noncompliance, DMRJ may declare the entire unpaid principal balance, together
with all interest accrued thereon, plus fees and expenses, due and
payable. Any such action on the part of DMRJ would have a material
adverse effect on our liquidity and financial condition and could force us to
curtail or discontinue all of our operations and/or file for protection under
bankruptcy laws.
On July
1, 2009, we entered into an amendment to the December 10, 2008 note and warrant
purchase agreement with DMRJ, pursuant to which we issued a senior secured
promissory note to DMRJ in the principal amount of $1,000,000.
The note
bears interest at the rate of 2.5% per month. The principal balance of the note,
together with all outstanding interest and all other amounts owed under the
note, will be due and payable on the earlier of (i) December 10, 2009 and (ii)
the receipt by us of net proceeds of at least $3,000,000 from the issuance of
debt and/or equity securities in one or more transactions. In addition, at our
option, DMRJ may require us to prepay such amounts upon (i) certain
consolidations, mergers and business combinations involving us; (ii) the sale or
transfer of more than 50% of our assets, other than inventory sold in the
ordinary course of business, in one or more related or unrelated transactions;
or (iii) the issuance by us, in one or more related or unrelated transactions,
of any equity securities or securities convertible into equity securities (other
than options granted to employees and consultants pursuant to employee benefit
plans approved by our Board of Directors), which results in net cash proceeds to
us of more than $500,000; provided, however, that DMRJ
may not require us to prepay more than the net cash proceeds of any
transaction described in the preceding clause (iii) of this sentence. We may
prepay all or any portion of the principal amount of the note, without penalty
or premium, after prior notice to DMRJ.
The
amendment to the loan agreement provides that, in the event we have not obtained
net proceeds from the issuance of debt or equity securities upon terms and
conditions acceptable to DMRJ in its sole discretion of (i) $1,000,000 by
July 24, 2009 and (ii) to the extent that we satisfied such requirements, an
additional $2,000,000 by August 21, 2009, we will immediately engage in a sale
process satisfactory to DMRJ in its sole discretion by implementing a
contingency plan which may be established by DMRJ, including, without
limitation, the
-17-
IMPLANT
SCIENCES CORPORATION
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS
engagement
at our expense of a third party investment banker acceptable to DMRJ in its sole
discretion. We did not satisfy these requirements and in August 2009, we engaged
Pickwick Capital Partners to market our Company for sale.
In
connection with the additional note issued on July 1, 2009, we also issued
871,763 shares of our Series F Convertible Preferred Stock to DMRJ, and agreed
that, if we were unable to obtain net proceeds of at least $3,000,000 from the
issuance of debt and/or equity securities by August 31, 2009, we would issue
774,900 additional shares of Series F Preferred Stock to DMRJ. DMRJ later
extended this deadline until October 1, 2009. We did not satisfy this
requirement and, on October 1, 2009, we issued such additional shares to DMRJ.
All of the 1,646,663
shares of Series F Preferred Stock held by DMRJ are convertible into 25%
of our common stock, calculated on a fully diluted basis. In addition, for so
long as the note or the amended and restated senior secured convertible
promissory note issued to DMRJ as of December 10, 2008 remain outstanding, we
may not issue additional shares of common stock, or other securities convertible
into or exercisable for common stock, if such securities would increase the
number of shares of our common stock, calculated on a fully diluted basis, unless we simultaneously
issue to DMRJ that number of additional shares of Series F Preferred Stock which
is necessary to result in the number of shares of common stock into which the
Series F Preferred Stock held by DMRJ may be converted representing the same
percentage ownership of us on a fully diluted basis after such issuance as
immediately prior thereto.
After the
repayment in full of the promissory notes, described above, the number of shares
of common stock into which the Series F Preferred Stock is convertible will
remain subject to “full ratchet” antidilution protection in the event that we
issue additional shares of common stock (or securities convertible into or
exercisable for additional shares of Common Stock) at a price below $.08 per
share. “Full ratchet” antidilution protection completely protects an investor’s
investment from subsequent price erosion until the occurrence of a liquidity
event. The anti-dilution protection will not apply, however, to issuances of
stock and options to our employees, directors, consultants and advisors pursuant
to any equity compensation plan approved by our stockholders.
The
Series F Preferred Stock is entitled to participate on an “as converted” basis
in all dividends or distributions declared or paid on our common stock. In the
event of any liquidation, dissolution or winding up of our Company, the holders
of the Series F Preferred Stock will be entitled to be paid an amount equal to
$.08 per share of Series F Preferred Stock, plus any declared but unpaid
dividends, prior to the payment of any amounts to the holders of our Series E
Convertible Preferred Stock or common stock by reason of their ownership of such
stock.
The
holders of the Series F Preferred Stock have no voting rights except as required
by applicable law. However, without the consent of the holders of a majority of
the Series F Preferred Stock, we may not (i) amend, alter or repeal any
provision of our Amended and Restated Articles of Organization or By-laws in a
manner that adversely affects the powers, preferences or rights of the Series F
Preferred Stock; (ii) authorize or issue any equity securities (or any equity or
debt securities convertible into equity securities) ranking prior and superior
to the Series F Preferred Stock with respect to dividends, distributions,
redemption rights or rights upon liquidation, dissolution or winding up; or
(iii) consummate any capital reorganization or reclassification of any of our
equity securities (or debt securities convertible into equity securities) into
equity securities ranking prior and superior to the Series F Preferred Stock
with respect to dividends, distributions, redemption rights or rights upon
liquidation, dissolution or winding up.
On August
5, 2009, we entered into a second amendment to the December 10, 2008 note and
warrant purchase agreement with DMRJ, pursuant to which we issued DMRJ
a bridge note in the principal amount of $700,000. The note
bears interest at the rate of 25% per annum. The principal balance of the note,
together with all outstanding interest and all other amounts owed under the
note, was due and payable on August 17, 2009. The outstanding
principal balance and interest due under this bridge note was paid on September
4, 2009.
On
September 4, 2009, we entered into an additional credit agreement with DMRJ,
pursuant to which DMRJ provided us with a revolving line of credit in the
maximum principal amount of $3,000,000. In connection with the credit agreement,
we issued a promissory note to DMRJ evidencing our obligations under the credit
facility. Each of our subsidiaries guaranteed our obligations under the credit
facility. Our obligations and our subsidiaries' obligations are secured by
grants of first priority security interests in all of our respective assets. In
addition, we agreed to cause all of our receivables and collections to be
deposited in a bank deposit account pledged to DMRJ pursuant to a blocked
account agreement. All funds deposited in the blocked collections account will
be applied towards the repayment of our obligations to DMRJ under the note.
Until the note and all of our obligations
-18-
IMPLANT
SCIENCES CORPORATION
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
thereunder
have been paid and satisfied in full, we will have no right to access or make
withdrawals from the blocked account without DMRJ’s consent.
The note
bears interest at the rate of 25% per annum. Interest under the note will be due
on the first day of each calendar month. The principal balance of the note,
together with all outstanding interest and all other amounts owed under the
note, will be due and payable on December 10, 2009. We may prepay all or any
portion of the principal amount of the note, without penalty or premium, after
prior notice to DMRJ. Subject to applicable cure periods, amounts due under the
note are subject to acceleration upon certain events of default, including: (i)
any failure to pay when due any amount owed under the note; (ii) any failure to
observe or perform any other condition, covenant or agreement contained in the
note or certain conditions, covenants or agreements contained in the credit
agreement; (iii) certain suspensions of the listing or trading of our common
stock; (iv) a determination that any misrepresentation made by us to DMRJ
in the credit agreement or in any of the agreements delivered to DMRJ in
connection with the credit agreement were false or incorrect in any material
respect when made; (v) certain defaults under agreements related to any of our
other indebtedness; (vi) the institution of certain bankruptcy and insolvency
proceedings by or against us; (vii) the entry of certain monetary judgments
against us that are not dismissed or discharged within a period of 20 days;
(viii) certain cessations of our business in the ordinary course; (ix) the
seizure of any material portion of our assets by any governmental authority; and
(x) our indictment for any criminal activity.
In lieu
of paying DMRJ any commitment fees, closing fees or other fees in connection
with the credit agreement, we agreed to pay DMRJ an additional amount equal to
50% of or aggregate net profits, as defined, generated between the closing date
through the termination of the credit facility. Such payments will be due and
payable as earned upon (i) each request for an advance under the note, and (ii)
the termination of the credit facility. For the period September 4,
2009 through September 30, 2009, we experienced a net loss and no such
paymentswere due or payable to DMRJ as of September 30,
2009.
Upon the
closing of the credit facility, we requested and were granted an initial advance
of approximately $1,633,000, of which we used approximately $715,000 to repay
all of our outstanding indebtedness to DMRJ pursuant to the bridge note
issued to DMRJ on August 5, 2009, and approximately $548,000 to retire certain
obligations owed to other parties. We used the balance of the initial advance
for working capital and ordinary course general corporate purposes.
As
of September 30, 2009, our obligations to DMRJ under the amended and restated
senior secured promissory note, the second senior secured promissory note and
under the credit facility approximated $4,600,000, $1,000,000 and $1,833,000,
respectively. Further, as of September 30, 2009, our obligation to
DMRJ for accrued interest under the amended senior secured promissory note and
under the credit facility approximated $108,000. All such amounts are due and
payable on December 10, 2009. The failure to refinance this indebtedness or
otherwise negotiate extensions of our obligations to DMRJ would have a material
adverse impact on our liquidity and financial condition and could force us to
curtail or discontinue operations entirely and/or file for protection under
bankruptcy laws.
14.
|
Series
D Convertible Preferred Stock
|
In
September 2005, we issued 500,000 shares of Series D Convertible Preferred
Stock, having a stated value of $10 per share, pursuant to a securities purchase
agreement with Laurus Master Fund, Ltd. for gross cash proceeds of
$5,000,000. The Series D Preferred Stock hadend equal to the prime
rate plus one percent and originally provided for redemption over a thirty-six
month period, pursuant to an amortization schedule.
We valued
the Series D Preferred Stock at issuance at its residual value of $2,700,000
based on the fair values of the financial instruments issued in connection with
this preferred stock financing, including certain warrants, the embedded
derivative instruments and offering costs. The amounts recorded in
the financial statements represent the amounts attributed to the sale of the
Series D Preferred Stock, the amount allocated to warrants, the value attributed
to the embedded derivatives and issuance costs. We accreted these
discounts on the carrying value of the Series D Preferred Stock to its
redemption value the actual conversion date. The accretion was
recorded as a preferred dividend in the period of accretion. For the
three months ended September 30, 2009 and 2008, $0 and $155,000, respectively,
was amortized.
-19-
IMPLANT
SCIENCES CORPORATION
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
We
received a waiver of the monthly redemption payments for the period December
2006 through August 2007 and resumed making monthly redemptions in September
2007. In September, 2008, Laurus agreed to extend the final redemption date to
October 24, 2008 in exchange for a redemption payment of $250,000, including
$22,000 of accrued dividends. We did not meet our redemption obligation on
October 24, 2008 and, on November 4, 2008, we amended our agreements with
Laurus, effective as of October 31, 2008, to provide that the amount necessary
to redeem in full the Series D Preferred Stock would be increased to $2,461,000,
together with accrued and unpaid dividends. The agreed upon redemption amount
for the Series D Preferred Stock included a penalty of approximately $568,000,
which amount was charged to interest expense in the fiscal year ended June 30,
2009.
On
October 31, 2009, we redeemed $268,000 of the $518,000 of Series D Preferred
Stock required to be redeemed on that date by agreeing to issue 929,535 shares
of our common stock to an affiliate of Laurus, and redeemed the balance due on
that date with a cash payment of $250,000. The shares were valued at $0.28829
per share, which was equal to the volume-weighted average price of our common
stock as reported by Bloomberg, L.P. for the 15-day period immediately preceding
the date of the amendment.
On
November 25, 2008 we redeemed an additional $800,000 of the Series D Preferred
Stock, using proceeds from the sale of the assets of Core Systems. On December
10, 2008, we used approximately $1,161,000 of the proceeds from the sale of
senior secured convertible promissory note to DMRJ to repay all of the
indebtedness outstanding to the Laurus, excluding the Series D Preferred Stock
redemption which was redeemed, in May 2009, when we issued 929,535 shares of our
common stock to an affiliate of Laurus completing the redemption of the Series D
Preferred Stock.
As
September 30, 2009 and June 30, 2009, the outstanding balance on the Series D
Preferred Stock was $0.
15.
|
Series E
Convertible Preferred Stock
|
In March
27, 2009, we announced the settlement of our litigation and the mutual release
by us and Evans Analytical Group, LLC of all claims related to the sale of
Accurel. In settling this litigation, we issued 1,000,000 shares of Series E
Convertible Preferred Stock, having an aggregate liquidation preference of
$5,000,000. The preferred stock, however, will be subject to cancellation,
without consideration and without liability to us, under certain conditions
related to our continued cooperation in the pursuit (as controlled and funded by
Evans and its counsel) of certain claims against a former officer of ours and
Accurel related to the sale of Accurel to Evans, including the outcome of such
litigation. The stock is convertible into common stock under various scenarios,
including by either party after the ninth anniversary of the settlement
agreement, and under certain other circumstances. The preferred stock will be
entitled to participate on an “as converted” basis in all dividends or
distributions declared or paid on our common stock and holders of the preferred
stock will have no voting rights except as required by applicable
law.
16.
|
Series
F Convertible Preferred Stock
|
In
connection with the July 1, 2009 amendment to the December 10, 2008 note and
warrant purchase agreement with DMRJ, pursuant to which we issued a senior
secured promissory note to DMRJ in the principal amount of $1,000,000, we issued
871,763 shares of our Series F Convertible Preferred Stock. The
871,763 shares of Series F Preferred Stock issued to DMRJ are convertible at the
option of DMRJ into 15% of our common stock, calculated on a fully diluted
basis.
If we do
not obtain net proceeds of at least $3,000,000 from the issuance of debt and/or
equity securities by August 31, 2009, we were required to issue to
DMRJ 774,900 additional shares of Series F Preferred Stock, such that all of the
Series F Preferred Stock then held by DMRJ will be convertible into 25% of our
common stock, calculated on a fully diluted basis. DMRJ extended the August 31,
2009 due date for us to obtain net proceeds of at least $3,000,000 to October 1,
2009. As of October 1, 2009, we have not obtained the required net
proceeds of at least $3,000,000 and have issued 774,900 additional shares of
Series F Preferred Stock to DMRJ. In addition, for so long as the note or
the amended and restated senior secured convertible promissory note issued to
DMRJ as of December 10, 2008 remain outstanding, we may not issue additional
shares of common stock, or other securities convertible into or exercisable for
common stock, if such securities would increase the number of shares of our
common stock, calculated on a fully diluted basis, unless we simultaneously
issues to DMRJ that number of additional shares of Series F Preferred Stock
which is necessary to result in the number of shares of common stock into which
the Series F Preferred Stock held by DMRJ may be converted representing the same
percentage ownership of us on a fully diluted basis after such issuance as
immediately prior thereto.
-20-
IMPLANT
SCIENCES CORPORATION
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS
We have
recorded the fair value of the Series F Preferred Stock of approximately
$378,000 against the senior secured convertible promissory note, which is
accreted to the note over the life of the note. The fair value of the
Series E Preferred Stock is equal to the fair value of the Company, defined as
the product of our common shares outstanding times the closing price of our
common stock on the date of issuance, multiplied by 25%. For the
three months ended September 30, 2009, $213,000 was accreted to the note and is
recorded as interest expense on our statement of operations.
17.
|
Stockholders’
Equity
|
Common
Stock Options and Warrants
In
connection with various financing agreements and services provided by
consultants, we have issued warrants to purchase shares of our common
stock. The fair value of warrants issued is determined using the
Black-Scholes option pricing model. In December 2008, in conjunction
with the issuance of the senior secured convertible note to DMRJ Group, LLC, we
issued five-year warrants to purchase 1,000,000 shares of common stock at an
initial exercise price of $0.26 per share. The warrant is exercisable
between December 10, 2008 and December 10, 2013. In consideration of
DMRJ Group LLC execution of the Consent Letter, on March 12, 2009, we entered
into an amended and restated warrant to purchase shares of common stock, to
reduce the initial exercise price of the warrant from $0.26 to $0.18 and
recorded the fair value of this warrant of approximately $160,000 against the
senior secured convertible promissory note, which is accreted to the note over
the life of the note.
As of
September 30, 2009, there were warrants outstanding to purchase 3,241,217 shares
of our common stock at exercise prices ranging from $0.09 to $12.45 expiring at
various dates between October 14, 2009 and June 27, 2015.
We did
not issue shares of common stock during the three months ended September 30,
2009 and 2008, as a result of the exercise of options by our employees and
consultants.
Employee
Stock Purchase Plan
During
the three months ended September 30, 2008, we issued 31,147 shares of our common
stock to our employees pursuant to the terms of the 2006 Employee Stock Purchase
Plan (the “ESPP”). There were no shares issued pursuant to the terms
of the ESPP during the three months ended September 30, 2009.
Treasury
Stock and Other Transactions
In June
2004, the Board authorized us to repurchase up to 300,000 shares of our common
stock, from time to time in the open market, privately negotiated transactions,
block transactions or at time and prices deemed appropriate by
management. As of September 30, 2009 and June 30, 2009, 10,545 shares
were held in treasury at cost. During each of the three months ended
September 30, 2009 and 2008, we repurchased no shares of our common
stock. As of September 30, 2009, the maximum number of shares
authorized to be repurchased were 289,455.
18.
|
Income
Taxes
|
We use
the liability method to accounting for income taxes. Under this method, deferred
taxes are determined based on the difference between the financial statement and
tax bases of assets and liabilities using enacted tax rates in effect in the
years in which the differences are expected to reverse. Deferred tax
assets are recognized and measured based on the likelihood of realization of the
related tax benefit in the future.
For the
three months ended September 30, 2009 and 2008, we provided for no taxes as we
have significant net loss carryforwards.
-21-
IMPLANT
SCIENCES CORPORATION
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS
19.
|
Investment
in CorNova
|
On
December 10, 2008, we transferred our entire interest in 1,500,000 shares
of the common stock of CorNova, Inc. to DMRJ Group LLC in lieu of commitment
fees, closing fees and other transaction related fees in connection with our
issuance of the senior secured convertible promissory note (See Note
13). As a result, $123,000 representing unrealized losses of our
share of CardioTech stock owned by CorNova which had been recorded as a separate
component of equity in other accumulated comprehensive loss were realized and
recorded to other expense in the statement of operations in the year ended June
30, 2009. In addition, we recorded a $468,000 gain on the transfer of
our investment in the CorNova common stock to other income in the statement
of operations in the year ended June 30, 2009. Prior to the transfer
of the CorNova shares, our ownership interest in CorNova was 15%. As
of September 30, 2009 and June 30, 2009, our investment in CorNova was
$0.
We had
historically accounted for our investment in CorNova, an unconsolidated
subsidiary, under the equity method, due in part, to the significant influence
we had over CorNova resulting from Dr. Anthony J. Armini serving on CorNova’s
Board of Directors. Dr. Armini served as our President and Chief
Executive Officer, resigning from both positions on September 27,
2007. As a result of Dr. Armini’s resignation in September 2007, the
equity method was no longer appropriate and the cost method was
used.
20.
|
Commitments
and Contingencies
|
We lease
manufacturing, research and office space in Wilmington, MA, the lease of which
expires on December 31, 2009. Under the terms of the lease, we are
responsible for our proportionate share of real estate taxes and operating
expenses relating to this facility. We lease a facility in Sunnyvale,
CA, which lease expires in September 2010. Effective with the sale of
the assets of Accurel Systems on May 1, 2007, we executed a sublease agreement
for one of our California facilities. As a result of the Ion
Metrics acquisition, we assumed a lease for research and office space in San
Diego, CA, which lease was renewed and expires on January 31,
2012. Total rent expense, including assessments for maintenance and
real estate taxes for the three months ended September 30, 2009 and 2008, for
both continuing and discontinued operations was $126,000 and $378,000,
respectively.
In
conjunction with the acquisition of Accurel, in March 2005, we recorded a lease
liability of $829,000. This liability reflected management’s estimate
of the excess of payments required under the Accurel facility lease, at the date
of acquisition, versus the fair market value of lease payments that would have
been required, had the lease been negotiated under current market
conditions. Subsequently, as a result of the sale of Accurel, we have
recorded an additional liability of $487,000 representing that portion of the
lease in excess of the sublease arrangement between Accurel Systems and Evans
Analytical Group, LLC. The balance of the lease liability on
September 30, 2009 is $451,000 which is included in current
liabilities.
In April
2009, Silicon Valley CA-I, LLC, the lessor of such property to Accurel, filed
suit against Accurel and Evans in the Superior Court of the State of California,
County of Santa Clara, alleging nonpayment of rent. On June 24, 2009, Accurel
entered into a release and settlement agreement with the lessor, under the terms
of which Accurel was required to pay $224,840, representing the amounts that are
past due under the lease, plus monthly rents owing under the lease, less the
payment that Evans is required to make under the terms of the settlement
agreement. Accurel is required to pay such amount on or before
September 4, 2009. On September 4, 2009, Accurel remitted the
settlement payment. In accordance with the release and settlement
agreement, provided that Accurel and Evans have complied with the terms of the
lease and payment in accordance with the agreement, the lessor has agreed to
dismiss the suit on or before September 14, 2009 and Accurel will have no
further obligations or liabilities to the lessor. As of November 12,
2009, the suit had not been dismissed.
In April
2007, in conjunction with our plans to conduct research, development and minor
manufacturing work in New Mexico, we executed an operating lease which was
initially to expire on May 1, 2010. The lease allowed for early
termination, which we elected in February 2008. As a result of the
early termination, we are responsible for reimbursing the landlord for certain
leasehold improvements over a 24-month period. As of June 30, 2009,
the balance due is approximately $27,000 and is included in current
liabilities.
-22-
IMPLANT
SCIENCES CORPORATION
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS
21.
|
Financial
Information By Segment
|
Operating
segments are defined as components of an enterprise about which separate
financial information is available that is regularly evaluated by the chief
operating decision maker or decision making group, in determining how to
allocate resources and in accessing performance. Our chief operating
decision making group is composed of the chief executive officer and members of
senior management. Based on qualitative and quantitative criteria, we
have determined that we operate within one reportable segment, which is the
Security Products Segment.
22.
|
Discontinued
Operations
|
Core
Systems
The
accompanying condensed consolidated balance sheets as of June 30, 2008 and
statements of operations for the three months ended September 30, 2009 and
2008 of C Acquisition Corp., our former wholly-owned semiconductor subsidiary,
which has operated under the name Core Systems, are presented as discontinued
operations. Our Board of Directors approved a plan to sell Core
Systems in February 2008. We has (i) eliminated Core Systems’
financial results from our ongoing operations, (ii) determined that Core
Systems, which operated as a separate subsidiary, was a separate component of
our aggregated business as, historically, management reviewed separately the
Core Systems financial results and cash flows apart from our ongoing continuing
operations, and (iii) determined that it will have no further continuing
involvement in the operations of Core Systems or cash flows from Core Systems
after the sale.
Condensed
results of operations relating to Core Systems for the three months ended
September 30, 2008 are as follows:
Three
Months Ended
|
||||
September
30,
|
||||
2008
|
||||
Revenues
|
$ | 1,506,000 | ||
Gross
profit
|
295,000 | |||
Operating
income
|
17,000 | |||
Non-operating
expense
|
(1,000 | ) | ||
Income
from discontinued operations
|
$ | 16,000 |
Medical
Business Unit
The
accompanying condensed consolidated balance sheets and statements of operations
present the results of the Medical Business Unit as discontinued
operations.
Condensed
results of operations relating to the Medical Business Unit for the three months
ended September 30, 2009 and 2008 are as follows:
Three
Months Ended
|
||||||||
September
30,
|
||||||||
2009
|
2008
|
|||||||
Revenues
|
$ | - | $ | 357,000 | ||||
Gross
profit
|
(20,000 | ) | 43,000 | |||||
Operating
(loss) income
|
(20,000 | ) | 43,000 | |||||
Gain
on sale of assets
|
- | 931,000 | ||||||
(Loss)
income from discontinued operations
|
$ | (20,000 | ) | $ | 974,000 |
-23-
IMPLANT
SCIENCES CORPORATION
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS
The
calculation of the gain on sale of medical business unit assets, recorded in the
statement of operations for the year ended September 30, 2008 is as
follows:
Three
Months Ended
|
||||
September
30,
|
||||
2008
|
||||
Proceeds
|
$ | 1,145,000 | ||
Direct
costs
|
20,000 | |||
Net
proceeds
|
1,125,000 | |||
Net
book value of assets sold
|
194,000 | |||
Gain
on sale of assets
|
$ | 931,000 |
The
assets and liabilities of the Medical Business Unit as of September 30, 2009 and
June 30, 2009 are as follows:
September
30,
|
June
30,
|
|||||||
2009
|
2009
|
|||||||
Assets
of Discontinued Operations
|
||||||||
Current
assets of discontinued operations:
|
||||||||
Accounts
receivable-trade, net
|
$ | 2,000 | $ | 51,000 | ||||
Inventories
|
103,000 | 118,000 | ||||||
Total
assets of discontinued operations
|
$ | 105,000 | $ | 169,000 | ||||
Liabilities
of Discontinued Operations
|
||||||||
Current
liabilities of discontinued operations:
|
||||||||
Accounts
payable
|
$ | 79,000 | $ | 96,000 | ||||
Accrued
expenses
|
- | 11,000 | ||||||
Total
liabilities of discontinued operations
|
$ | 79,000 | $ | 107,000 |
23.
|
Legal
Proceedings
|
From time
to time, we are subject to various claims, legal proceedings and investigations
covering a wide range of matters that arise in the ordinary course of our
business activities. Each of these matters is subject to various
uncertainties.
Evans
Analytical Group LLC
In
conjunction with the May 2007 sale of our Accurel business to Evans Analytical,
Accurel entered into a sublease of its facility to Evans. In April
2009, Silicon Valley CA-I, LLC, the lessor of such property to Accurel, filed
suit against Accurel and Evans in the Superior Court of the State of California,
County of Santa Clara, alleging nonpayment of rent. On June 24, 2009, Accurel
and Evans entered into a release and settlement agreement with the lessor, under
the terms of which Accurel was required to pay $224,840, representing the
amounts that are past due under the lease, plus monthly rents owing under the
lease, less the payment that Evans is required to make under the terms of the
settlement agreement. Accurel was required to pay such amount on or
before September 4, 2009. On September 4, 2009, Accurel
remitted the settlement payment. In accordance with the release and
settlement agreement, provided that Accurel and Evans have complied with the
terms of the lease and payment in accordance with the agreement, the lessor has
agreed to dismiss the suit on or before September 14, 2009, and Accurel will
have no further obligations or liabilities to the lessor. As of November
12, 2009, the suit had not been dismissed.
We may,
from time to time, be involved in other actual or potential proceedings that it
considers to be in the normal course of our business. We do not
believe that any of these proceedings will have a material adverse effect on our
business.
-24-
Item
2.
|
Management’s
Discussion and Analysis of Financial Condition and Results of
Operations
|
Cautionary
Note Regarding Forward-Looking Statements
This
Quarterly Report on Form 10-Q contains certain statements that are
“forward-looking” within the meaning of the Private Securities Litigation Reform
Act of 1995 (the “Litigation Reform Act”). These forward looking
statements and other information are based on our beliefs as well as assumptions
made by us using information currently available.
The words
“anticipate,” “believe,” “estimate,” “expect,” “intend,” “will,” “should” and
similar expressions, as they relate to us, are intended to identify
forward-looking statements. Such statements reflect our current views
with respect to future events, are subject to certain risks, uncertainties and
assumptions, and are not guaranties of future performance. Should one
or more of these risks or uncertainties materialize, or should underlying
assumptions prove incorrect, actual results may vary materially from those
described herein as anticipated, believed, estimated, expected, intended or
using other similar expressions.
In
accordance with the provisions of the Litigation Reform Act, we are making
investors aware that such forward-looking statements, because they relate to
future events, are by their very nature subject to many important factors that
could cause actual results to differ materially from those contemplated by the
forward-looking statements contained in this Report. Important factors
that could cause actual results to differ from our predictions include those
discussed under this “Management’s Discussion and Analysis” and under "Risk
Factors." Although we have sought to identify the most significant risks
to our business, we cannot predict whether, or to what extent, any of such risks
may be realized, nor can there be any assurance that we have identified all
possible issues which we might face. In addition, assumptions
relating to budgeting, marketing, product development and other management
decisions are subjective in many respects and thus susceptible to
interpretations and periodic revisions based on actual experience and business
developments, the impact of which may cause us to alter our marketing, capital
expenditure or other budgets, which may in turn affect our financial position
and results of operations. For all of these reasons, the reader is
cautioned not to place undue reliance on forward-looking statements contained
herein, which speak only as of the date hereof. We assume no
responsibility to update any forward-looking statements as a result of new
information, future events, or otherwise except as required by
law. We urge readers to review carefully the risk factors described
in this Quarterly Report, in our Annual Report on Form 10-K for the fiscal year
ended June 30, 2009, as amended, and in the other documents that we file with
the Securities and Exchange Commission. You can read these documents
at
www.sec.gov.
Overview
We
develop, manufacture and sell sophisticated sensors and systems for the
Security, Safety and Defense (“SS&D”) industries. A variety of
technologies are currently used worldwide in security and inspection
applications. In broad terms, the technologies focus on detection in
two major categories: (i) the detection of “bulk” contraband, which includes
materials that would be visible to the eye, such as weapons, explosives,
narcotics and chemical agents; and (ii) the detection of “trace” amounts of
contraband, which includes trace particles or vapors of explosives, narcotics
and chemical agents. Technologies used in the detection of “bulk”
materials include computed tomography, transmission and backscatter x-ray, metal
detection, trace detection and x-ray, gamma-ray, passive millimeter wave, and
neutron analysis. Trace detection techniques include mass
spectrometry, gas chromatography, chemical luminescence, or ion mobility
spectrometry.
We have
developed proprietary technologies used in explosives trace detection (“ETD”)
applications and market and sell handheld and bench top ETD systems that use our
proprietary ETD technologies. Our products are marketed and sold to a
growing number of locations domestically and internationally. These
systems are used by private companies and government agencies to screen baggage,
cargo, vehicles, other objects and people for the detection of trace amounts of
explosives.
History
Since our
incorporation in August 1984, we have operated as a multi-faceted company
engaging in the development of ion-based technologies and providing commercial
services and products to the semiconductor, medical device and security
industries. As further discussed in the Business Strategy section
below, however, we have recently divested our semiconductor and medical business
activities in order to focus on our security business.
-25-
Semiconductor Business
Unit
Our
business began as a result of the development of our proprietary ion-beam
technology and application of this technology in services to the semiconductor
industry. At the outset, our initial business was to provide ion
implantation services to the semiconductor industry for surface modification of
silicon wafers. Our services were provided to semiconductor
companies, universities and research facilities as an outsource provider of
these ion implantation services. These services were performed at our
Massachusetts facility, where we maintained and operated several ion
implanters.
In
October 2004, we acquired Core Systems Inc., a privately-held semiconductor
wafer processing company located in Sunnyvale, California for $7,486,000 in cash
and common stock of the Company. In February 2008, our Board approved
a formal plan to sell Core as part of our strategic initiative to focus on our
security business. For the three months ended September 30, 2008, the
operations of Core have been recorded in our statements of operations as
discontinued operations.
In March
2005, we acquired Accurel Systems International Corporation, a privately-held
semiconductor wafer analytical services company located in Sunnyvale, California
for $12,176,000 in cash and common stock of the Company. In March
2007, our Board approved a formal plan to sell Accurel as part of our strategic
initiative to focus on our security business. In May 2007, we
completed the sale of Accurel to Evans Analytical Group LLC in exchange for cash
of $12,705,000, of which $1,000,000 was placed in escrow.
In
February 2008, Evans filed suit requesting rescission of the acquisition
agreement, plus damages, based on claims of misrepresentation and
fraud. In March 2008, Evans filed a claims notice with the escrow
agent prohibiting release of any portion of the escrowed funds pending
resolution of the lawsuit. On March 27, 2009, we announced the
settlement of this litigation and the mutual release by the Company and Evans of
all claims related to the sale of Accurel. In settling this
litigation, we agreed to pay Evans damages in the amount of approximately
$5,700,000 by (i) agreeing to release to Evans approximately $700,000 that had
been held in escrow since the time of the closing and (ii) issuing to Evans
1,000,000 shares of Series E Convertible Preferred Stock having an aggregate
liquidation preference of $5,000,000. Please see more detailed
discussions of the Evans matter in Notes 15 and 23 to our consolidated financial
statements.
Medical Business
Unit
We also
used our ion beam technology to develop ion implantation and thin film coatings
applications for medical devices. As a result of these technologic
advancements, which were in part funded by government research grants and
awards, we were able expand our business and provide services and products to
the medical industry. The primary medical related businesses in which
we engaged were (i) providing services to medical device companies for surface
modification of implantable devices, (ii) the development of brachytherapy
products, and (iii) the manufacture and sales of our proprietary radioactive
seeds for the treatment of prostate cancer.
We
provided ion implantation services to modify orthopedic joint implant surfaces,
resulting in reduced polyethylene wear and increased implant life, through the
second quarter of fiscal 2007. In the second quarter of fiscal 2007,
the customer discontinued its product line using our ion implantation
services. Using similar technology, we developed applications for
coatings of cardiovascular devices, such as coronary stents. In May
1999, we received Food and Drug Administration 510(k) clearance to market our
radioactive seed for the treatment of prostate cancer. We began
commercial sales of our radioactive seed in fiscal 2001.
In
further support of our strategic initiative to focus on our security business,
in June 2007, we sold certain of the assets related to our brachytherapy
products and divested our prostate seed and medical software
businesses. In March 2008, we informed our medical coatings customers
of our intention to discontinue coating operations by the end of the 2008
calendar year. During the three months September 30, 2008 we sold certain assets
associated with our medical coatings and ion implantation
businesses. As of September 30, 2009 and June 30, 2009, the assets
and liabilities of the Medical Business Unit have been recorded on our balance
sheet as held-for-sale. For the three months ended September 30, 2009
and 2008, the operations of the Medical Business Unit have been recorded in our
statements of operations as discontinued operations.
-26-
Security Business
Unit
Since May
1999, we have been performing research to improve ETD technology, and
development of ETD products that can be used for detection of trace amounts of
explosives. At present, we have developed both portable and benchtop
systems, which have been marketed and sold both domestically and
internationally. In order to reduce manufacturing costs and be
responsive to large quantity orders, we use a contract
manufacturer. As we continue to sell and deliver our security
products, we work both independently and in conjunction with various government
agencies to develop the next generation of trace explosives detectors and to
identify new applications for our proprietary technology.
In April
2008, we acquired all of the capital stock of Ion Metrics, Inc., located in San
Diego, California. Ion Metrics develops mass sensor systems to detect
and analyze chemical compounds such as explosives, chemical warfare agents,
narcotics, and toxic industrial chemicals for the homeland defense, forensic,
environmental, and safety/security markets. Ion Metrics' miniaturized
devices and system designs provide high performance and reliability in
combination with low manufacturing costs. Ion Metrics' operating results
have been included in our statement of operations commencing on April
10, 2008.
Technology
and Intellectual Property
Since May
1999, we have performed research and development in the area of
ETD. We have developed several proprietary technologies in key areas
of ETD which we believe improve the harvesting, collection and detection of
trace particles and vapors of explosives substances. In addition, we
are continuing our development efforts to adapt this technology for the
detection of narcotics and other chemical agents. Our intellectual
property portfolio contains 17 security-related patents and patents
pending: eight issued United States patents, eight United States
patents pending, and one licensed patent. We believe that our
portfolio of patents and patents pending provides extensive protection in sample
harvesting, sample detection and collection. A key to our past and
future success is our ability to innovate and offer differentiation in these
areas.
We
compartmentalize ETD into four major areas: i) harvest, ii) transport, iii)
analysis, and iv) reporting. These technologies are discussed in
detail in the following sections.
Harvest
- Aerosol Particle Release
Tiny
particles of explosives and narcotics are “sticky” and may adhere to
surfaces. Particles could be transferred if an object, such as
fingers or clothing, comes in contact with a particle. We have
demonstrated that a person touching an explosives material can transfer
explosives particles to numerous other objects leaving a trail of particles
behind.
Our
competitors commonly swipe a surface to be interrogated for explosives particles
with cloth or paper. We believe that this “contact” methodology
provides an effective but inconsistent method of harvesting sample as compared
to an automated, non-contact collection of the trace sample. We have
developed a method, which we believe to be more efficient, using an aerosol of
fine dry ice particles. This technique, which is surprisingly
inexpensive to use, could increase collection sensitivity substantially and
eliminate direct contact with a surface. Our aerosol technology
functions as a very gentle version of “sandblasting” and is safe for almost all
surfaces. Since dry ice sublimes into gas, no residue is left behind,
and the aerosol may be used indoors. We have two patents pending on
this methodology.
Transport
Vortex
Sampling
Once the
trace particle has been released from a surface, it has to be transported to a
collection point. Vortex sampling was the first of our sampling
innovations. We have three patents issued and two patents pending in
the area of vortex sampling methodology.
Our
vortex is similar to a miniature tornado. A hollow spinning cylinder
of air flowing outward surrounds and protects an inner vacuum flowing
inward. This vortex sampling technology enables particles released
within the vortex, or blown into it, to be transported with high efficiency to a
collection filter.
-27-
Long-Life Sample
Trap
Once
particles have been liberated from the surface being interrogated, the particles
are transported to our innovative trapping filter, which is an ultra-fine
stainless steel woven mesh. The trapping filter has a long usable
life, which could span several years, requiring inexpensive, routine
maintenance. We believe the trapping filter provides an innovative
solution to the more costly consumables used by several of our competitors
engaged in ETD using contact methodology for sampling and
detection.
Analysis
Flash
Desorption
Flash
desorption is an optical method for converting the chemistry of a particle, such
as the chemicals composing explosives or narcotics, into a vapor that can be
subjected to analyses for the discrimination of chemical
properties. In conventional trace chemical detectors, a sample is
slowly warmed in an oven producing diluted vapor with low chemical
concentrations. Optical flash vaporization heats a sample within
microseconds, producing a high sample concentration for detection.
This
method is not appropriate with conventional sample collection methods, such as
paper wipes, because the paper is white, and the light from the bright flash
reflects off, producing little heating. However, by using our
trapping filter, a very fast detection response can be achieved without loss in
sensitivity. We have two patents issued and one patent pending in the
area of flash desorption methodology. The first product under
development to take advantage of our flash desorption technology is our air
cargo screening system described under “Products” below.
Photonic
Ionization
The
conventional method of ionizing vapors for analysis is to use a radioactive beta
source. While ETD equipment using radioactive sources are simple,
effective, and need no electricity in the ionization process, there are
important issues involving safety, licensing, regular verification of source
integrity, and disposal. Some markets, such as Japan and Australia,
are known to reject instruments with radioactive sources. We believe
that most markets would prefer not to have to address the issues surrounding ETD
equipment with radioactive sources.
We have
developed two types of photonic, non-radioactive ion sources for our instruments
for applications requiring either the ionization of positive ions or negative
ions. These ion sources may be found individually or in combination
within our products, depending on the application for which the ETD equipment is
to be used. We have two patents pending in the area of photonic
ionization.
Reporting
Reporting
is that portion of the cycle that displays and stores information generated
during the analysis phase. This information a system operator sees
and indicates if an alarm condition exists or if the test is
negative. Information can be displayed in both graphical and tabular
formats. The reporting also indicates when the instrument is ready
for the next sample as well as displaying built-in system
diagnostics.
Products
We have
developed several explosives detection systems designed for use in aviation and
transportation security, high threat facilities and infrastructure, military
installations, customs and border protection, and mail and cargo
screening. The systems use our proprietary Quantum SnifferTM
technologies, including photon-based, non-radioactive ion source in combination
with ion mobility spectrometry, a classic detection tool sensitive to the unique
speeds with which ions of various substances move through the air (“IMS”) to
electronically detect minute quantities of explosives vapor and
particles.
Current
Products
Quantum SnifferTM QS-H150 Portable Explosives
Detector
The
Quantum Sniffer QS-H150 Portable Explosives Detector employs a patented vortex
collector for the simultaneous detection of explosives particulates and vapors
with or without physical contact and in real-time. We believe that
our advanced QS-H150 is more sensitive than other detection
devices. The QS-HS150 can detect vapors and nanogram quantities of
explosives particulates for most explosives substances considered to be
threats. Such substances include, but are not limited to, military
and commercial explosives, improvised and homemade explosives, and propellants
and taggants.
-28-
The
QS-H150 has automatic and continuous self-calibration. It monitors
its environment, senses changes that would affect its accuracy, and
re-calibrates accordingly. The system requires no user intervention
and no calibration consumables. The detection process begins with the
collection of a sample with our patented vortex collector. After
collection, the sample is ionized photonically and analyzed using IMS
technology. The presence of a threat substance is indicated by a
visible and audible alarm. The threat substance is then identified
and displayed on the integrated LCD screen. Optionally, and at any
time, a monitor and keyboard may be connected for convenient access to
spectrogram display and analysis tools, administrative tools, and
diagnostics.
When
detecting a threat substance, the QS-H150 rapidly alarms. This
real-time detection limits equipment contamination and allows for fast
clear-down. Operation and maintenance are
cost-effective. Since there is no requirement for dopants,
calibration consumables or verification consumables, the overall cost of
consumables is minimized. Routine maintenance consists only of
care and cleaning using common supplies, and desiccant replacement as
required. No radioactive material used in the QS-H150, so there are
no associated certifications, licenses, inspections, or end-of-life disposal
issues.
Quantum SnifferTM QS-B200 Benchtop Explosives
Detector
The
QS-B200 Benchtop Explosives Detector uses dual IMS with non-radioactive
ionization for the detection and identification of a wide range of military,
commercial, and improvised explosives. The QS-B200 has automatic and
continuous self-calibration. It monitors its environment, senses
changes that would affect its accuracy, and re-calibrates
accordingly. For detection, the sample is collected with a standard
trap, ionized, and analyzed via IMS. The presence of a threat is
indicated by a visible and audible alarm, and the substance is identified and
displayed on the integrated touch screen display. Users may save data
locally, print via a built-in thermal printer, or send data through standard
interfaces such as USB, LAN, etc. Multi-level password-protected data
security is standard. We believe that the operation and maintenance
of the QS-B200 are extremely cost-effective. Routine maintenance consists only
of care and cleaning using common supplies, and desiccant replacement as
required. No radioactive material is used in the QS-B200, so there
are no associated certifications, licenses, inspections, or end-of-life disposal
issues.
Products
Under Development
Quantum SnifferTM QS-H300 Air Cargo Screening
System
With the
assistance of funding from the U.S. Department of Homeland Security ("DHS"), we
have developed a hand sampler detector that utilizes our proprietary jetted
vortex collector for non-contact collection of trace particulate
materials. We believe the hand sampler, which will be a compact,
lightweight device, could significantly improve explosives detection
capabilities while also being very user friendly. Our non-contact
method could prove to be more effective than traditional contact sample
collection methods, and at a much lower cost to users. This improved
sampling process has applicability for use in detecting trace amounts of
explosives found on a wide range of objects such as carry-on luggage, parcels,
packages and cargo. In addition, multiple handheld sampling units
could be systematically deployed in concert with a centralized trace explosives
detection system to improve efficiency and increase the number of articles
screened. We believe this product could usher in a new way of
thinking about how cargo and other items can be properly examined in a
cost-effective and user friendly manner. We introduced the QS-H300 at
the AVSEC 2008 exhibition in Seoul, South Korea in November 2008.
Miniature Mass
Spectrometer
We
initially developed our own proprietary ion mobility
spectrometer. We believe that as market demand grows for
greater precision of substance identification and the list of substances to be
detected increases, more advanced detectors will be required.
Our
acquisition of Ion Metrics enabled us to obtain miniaturized quadrupole mass
spectrometry (“QMS”) detector technology. The QMS detector is roughly
the size of an AA battery and has low manufacturing costs. When used
in conjunction with an IMS, the QMS detector senses the molecular weight of the
chemical species resulting in an “orthogonal” detection method in which a more
fundamental characteristic of a substance is measured. We believe
that, because it is unlikely that two substances would share the same mass and
the same ion mobility in air, QMS detector technology improves the accuracy of
detection and minimizes false alarms. We are currently developing
interfaces for integrating the QMS detector into our future
products.
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Hyphenated
Detectors
Depending
on the application and the number of “interfering” background chemicals, it may
be necessary to incorporate additional “orthogonal” detection
methods. The combination of multiple sensors is commonly known as
hyphenated systems. By measuring different properties of the same
species, interferents are separated from target species for a deterministic
detection and identification and have minimum rates of false alarms. The
combination of these sensors in series is commonly known as employing
“hyphenated” detection methods. A hyphenated system is one in which a
sequence of different types of detectors all must agree that an alarm has
occurred before a valid alarm is declared.
We are
currently developing hyphenated systems employing conventional ion mobility,
differential mobility and mass spectrometry for the DHS.
We
believe detection systems incorporating hyphenated detection methods could
accelerate the expansion of our product line to more effectively address the
needs of the security, safety and defense sector, as well as accelerate our
entry into the narcotics, chemical warfare, biological warfare and toxic
industrial chemical detection marketplaces. Combining new
technologies with our other innovative products could enhance our competitive
position while improving sales volumes and product margins in the future. We expect hyphenated systems to appear in our future
product offerings.
Manufacturing
Operations
We
manufacture our security products primarily through a sole source contract
manufacturer located locally in Worcester, Massachusetts. We believe
our strategy to outsource manufacturing reduces manufacturing costs,
improve scheduling flexibility, and allow us to focus our internal resources and
management on product development, marketing, sales and
distribution. We also maintain an internal production group at our
corporate headquarters in Wilmington, Massachusetts responsible for
pre-production logistics, oversight of contract manufacturing, quality control
and inventory management.
Critical
Accounting Policies
Our
significant accounting policies are summarized in Note 2 to our consolidated
financial statements included in Item 7 of our Annual Report on Form 10-K, as
amended, for the fiscal year ended June 30, 2009. However, certain of
our accounting policies require the application of significant judgment by our
management, and such judgments are reflected in the amounts reported in our
condensed consolidated financial statements. In applying these
policies, our management uses our judgment to determine the appropriate
assumptions to be used in the determination of estimates. Those
estimates are based on our historical experience, terms of existing contracts,
our observance of market trends, information provided by our strategic partners
and information available from other outside sources, as
appropriate. Actual results may differ significantly from the
estimates contained in our condensed consolidated financial
statements. There has been no change to our critical accounting
policies through the fiscal quarter ended September 30, 2009.
Results
of Operations
Three Months Ended September
30, 2009 vs. September 30, 2008
Revenues
Security
revenues for the three months ended September 30, 2009 were $1,820,000 as
compared with $5,948,000 for the comparable prior year period, a decrease of
$4,128,000 or 69.4%. Revenue from security products for the three
months ended September 30, 2009 were $1,635,000 as compared with $5,302,000 for
the comparable prior year period, a decrease of $3,667,000 or
69.2%. Revenue from government-funded contracts for the three months
ended September 30, 2009 were $185,000 as compared with $646,000 for the
comparable prior year period, a decrease of $461,000 or 71.4%. The
decrease in security revenue is primarily a result of a decrease in the number
of units sold of our explosives detection products during the three months ended
September 30, 2009 as compared to comparable prior year period. In the
period, we made significant shipments of our handheld explosives detection
equipment to a customer in China aggregating approximately $4,169,000 in sales,
which shipments coincided with security preparations for the Beijing Olympics.
Revenue from government contracts decreased due to the expiration of several
contracts in the three-month period ended September 30, 2009 which could result
in reduced government contract revenues in fiscal 2010, unless we are successful
in securing additional government contracts. We will continue to pursue these
grants and contracts to support our research and development efforts in the
areas of trace explosives detection.
-30-
Cost
of Revenues
Cost of
revenues for the three months ended September 30, 2009 were $979,000 as compared
with $3,172,000 for the comparable prior year period, a decrease of $2,193,000
or 69.1%. The decrease in cost of revenues is primarily a result of
the decrease in unit sales of security product in the three months ended
September 30, 2009.
Gross
Margin
Gross
margin for the three months ended September 30, 2009 was $841,000 or 46.2% of
security revenues as compared with gross margin of $2,776,000 or 46.7% of
security revenues for the comparable prior year period. The decrease
in gross margin is a result of competitive pricing pressures and increased per
unit manufacturing overhead, as overhead costs were allocated to a reduced
volume.
Research,
Development and Regulatory Expenses
Research
and development expense for the three months ended September 30, 2009 was
$595,000 as compared with $1,020,000 for the comparable prior year period, a
decrease of $425,000 or 41.7%. We continue to expend funds to further
the development of new products in the areas of explosives detection, as well as
to prepare for certain government laboratory acceptance testing. The
decrease in research and development expenses in the three months ended
September 30, 2009 is due primarily to decreased payroll and related fringe
benefits costs resulting from a reduction in personnel and reduced engineering
consulting fees.
Selling,
General and Administrative Expenses
Selling,
general and administrative expenses for the three months ended September 30,
2009 was $1,227,000 as compared with $2,366,000 for the comparable prior year
period, a decrease of $1,139,000, or 48.1%. The decrease in selling,
general and administrative expenses is due primarily to decreased payroll and
related fringe benefits costs resulting from a reduction in personnel, decreased
variable selling expenses due to the significant decrease in sales of our
security products and decreased legal and audit fees, partially offset by an
increase in loan financing fees.
Other
Income and Expense, Net
For the
three months ended September 30, 2009, we recorded other expense, net of
$648,000 as compared with other expense, net of $24,000, for the comparable
prior year period, an increase of $624,000. The increase in other
expense, net, is primarily a result of an increase in interest expense of
$634,000 due to increased borrowings under our senior secured convertible
promissory note and under our credit facility with DMRJ Group,
LLC and to higher interest rates on these
borrowings. Interest income increased $10,000 to $18,000, in the
three months ended September 30, 2009 from $8,000, for the comparable prior year
period, due to interest income associated with the note receivable issued to us
as part of the Core asset sale.
Loss
from Continuing Operations
Loss from
continuing operations for the three months ended September 30, 2009 was
$1,629,000 as compared with a loss of $634,000 for the comparable prior year
period, an increase of $995,000, or 156.9%. The increase in loss from
continuing operations is due primarily to decreased sales of our security
products and an increase in interest expense, offset partially by a decrease in
operating expenses.
Preferred
Distribution, Dividends and Accretion
Preferred
distribution, dividends and accretion on the Series D Convertible Preferred
Stock for the three months ended September 30, 2009 was $0 as compared with
$189,000 for the comparable prior year period, a decrease of
$189,000. The Series D Preferred Stock was extinguished on December
10, 2008.
Income
(Loss) from Discontinued Operations
The net
loss from discontinued operations for the three months ended September 30, 2009
was $20,000 as compared with income from discontinued operations of $990,000 for
the comparable prior year period, a decrease of $1,010,000. The net
loss from discontinued operations for the three months ended September 30, 2009
is composed of operating loss of $20,000 from our medical reporting
unit. Income from discontinued operations for the three months ended
September 30, 2008 includes: (i) income of $43,000 from operations of our
medical reporting unit, (ii) income of $16,000 from the operations of
semiconductor business, and (iii) a gain on sale of assets of our medical
reporting unit of approximately $931,000.
-31-
Liquidity
and Capital Resources
As of
September 30, 2009, we had approximately $332,000 of cash and cash equivalents,
an increase of $332,000 when compared with a balance of $0 as of June 30,
2009. On December 10, 2009, we must repay in full our obligations to
DMRJ under an amended and restated senior secured promissory note
issued to DMRJ as of December 10, 2008, under a second secured
promissory note issued on July 1, 2009 and under a revolving
credit facility established on September 4, 2009. As of September 30,
2009, our obligations under the two senior notes and under the revolving
credit facility were $4,600,000, $1,000,000 and $1,833,000, respectively.
Each of these notes and the credit facility are described in more detail
below. As of November 12, 2009 our obligation to DMRJ under the two
senior notes and under the revolving credit facility were $4,600,000,
$1,000,000 and $2,127,000, respectively.
During
the three months ended September 30, 2009 we had net cash outflows of $2,529,000
from operating activities of continuing operations as compared to net cash
inflows from operating activities of continuing operations of $973,000 for the
comparable prior year period. The $3,502,000 decrease in net
cash used in operating activities of continuing operations during the three
months ended September 30, 2009, as compared to the comparable prior year
period, was primarily a result of (i) an increase in our loss from operations of
$995,000 due to lower sales of our security products, (ii) a decrease in
accounts payable of $1,100,000 due to the payment of outstanding obligations
and, (iii) a decrease of $988,000 in deferred revenue due primarily due the
timing of customer advance payments. For the three months ended
September 30, 2009, we had net cash inflows of $16,000 from operating activities
of discontinued operations, compared with net cash inflows of $223,000 from
operating activities of discontinued operations for the comparable prior year
period, a decrease of $207,000, due primarily to a increase in the loss from
discontinued operations and a decrease in cash provided by accounts receivable
in the three months ended September 30, 2009.
During
the three months ended September 30, 2009 we had net cash inflows of $17,000
from investing activities of continuing operations as compared to net cash
inflows of $1,001,000 from investing activities of continuing operations for the
comparable prior year period. The $984,000 decrease in net cash
provided by investing activities of continuing operations during the three
months ended September 30, 2009, as compared to the comparable prior year
period, was primarily a result of cash provided from the sale of assets of our
medical business unit. For the three months ended September 30, 2009,
we had no net cash outflows from investing activities of discontinued
operations, compared to net cash outflows of $18,000 from investing activities
of discontinued operations for the comparable prior year period, due primarily
to a decrease in cash used to purchase property and equipment.
During
the three months ended September 30, 2009 we had net cash inflows of $2,828,000
from financing activities of continuing operations as compared to net cash
outflows of $577,000 from financing activities of continuing operations for the
comparable prior year period. The $3,405,000 increase in net
cash from financing activities of continuing operations during the three
months ended September 30, 2009, as compared to the comparable prior year
period, was primarily a result of $1,000,000 in cash provided by
the issuance of a senior secured note to DMRJ in July 2009 and
$1,833,000 in cash provided by the temporary credit facility provided by
DMRJ in September 2009. During the three months ended September 30,
2008, we used $337,000 to pay dividends and redeem our Series D Preferred
Stock and used $264,000 to reduce our obligations to Bridge Bank under our term
note and revolving credit facility. For the three months ended September 30,
2009, we had no net cash outflows from financing activities of discontinued
operations compared with net cash outflows of $1,000 from financing activities
of discontinued operations for the comparable prior year period, due to
decreased principal payments of capital lease obligations. We expect
that the absence of cash flows from our discontinued operations will not have a
negative impact on our future liquidity and capital resources.
On
December 10, 2008, we entered into a note and warrant purchase agreement with
DMRJ Group LLC, an accredited institutional investor, pursuant to which we
issued a senior secured convertible promissory note in the principal amount of
$5,600,000 and a warrant to purchase 1,000,000 shares of our common
stock. The note bears interest at 11.0% per annum and is
collateralized by all of our assets. The effective interest rate on
the note is approximately 23.4%. We prepaid interest in the amount of
$616,000 upon the issuance of the note. In lieu of paying any
commitment fees, closing fees or other fees in connection with the purchase
agreement, we transferred our entire interest in 1,500,000 shares of the common
stock of CorNova, Inc., a privately-held devlopment stage medical device
company, to DMRJ. The note, which has been amended and
restated, as described below, was originally convertible in whole or
in part at the option of DMRJ into shares of our common stock at a conversion
price of $0.26 per share.
-32-
We valued
the note upon issuance at its residual value of $4,356,000 based on the fair
values of the financial instruments issued in connection with this convertible
debt financing, including the warrant, the original issue discount and the fair
value of the CorNova common stock transferred to DMRJ. The amounts
recorded in the financial statements represents the amounts attributed to the
senior secured convertible debt of $5,600,000, net of $160,000 allocated to the
warrant, $616,000 of original issue discount and $468,000 representing the
estimated fair value of the CorNova common stock. The warrant was
valued using the Black-Scholes model with the following
assumptions: volatility 98.4%, risk-free interest rate of 2.29%,
expected life of five years and expected dividend yield of 0.00%. As
required under the terms of the note, we made a principal payment of $1,000,000
on December 24, 2008. The note required us to make a principal
payment in an amount equal to any funds released from the escrow created in
connection with the May 2007 sales of the assets of Accurel Systems
International, upon the release of such funds. DMRJ
waived that requirement in connection with the Evans litigation
settlement.
On March
12, 2009, we entered into a letter agreement with DMRJ pursuant to which we were
granted access to $250,000 of previously restricted cash out of funds held in a
blocked account. The effect of the letter agreement made $250,000
available to us until the close of business on April 14, 2009. In
consideration of the letter agreement, on March 12, 2009, we issued an amended
and restated senior secured convertible promissory note and amended and restated
warrant to DMRJ to purchase shares of common stock, which replaced the note and
warrant issued on December 10, 2008. The terms of the amended and
restated note and the amended and restated warrant are identical to the terms of
the original note and warrant, except that the amended instruments reduced the
initial conversion price of the original note from $0.26 to $0.18 and reduced
the initial exercise price of the original warrant from $0.26 to
$0.18.
The
remaining principal balance of the amended and restated note, together with
outstanding interest, is due and payable on December 10, 2009.
The note
contains restrictions and financial covenants including: (i) restrictions
against declaring or paying dividends or making any distributions; against
creating, assuming or incurring any liens; against creating, assuming
or incurring any indebtedness; against merging or consolidating with any other
company, provided, however, that a merger or consolidation is permitted if
we are the surviving entity; against the sale, assignment, transfer or
lease of our assets, other than in the ordinary course of business and excluding
inventory and certain asset sales expressly permitted by the note purchase
agreement; against making investments in any company, extending credit or loans,
or purchasing stock or other ownership interest of any company; and (ii)
covenants that we have authorized or reserved for the purpose of issuance, 150%
of the aggregate number of shares of our common stock issuable
upon exercise of the warrant, that we maintain a minimum cash
balance of at least $500,000; that the aggregate dollar amount of all
accounts payable be no more than 100 days past due; and that we maintain a
current ratio, defined as current assets divided by current
liabilities, of no less than 0.60 to 1.00. As
of September 30, 2009, our current ratio was 0.21 to 1.00, the aggregate
dollar amount of all of our accounts payable exceeded 100 days past due and the
minimum cash balance required to be maintained in the blocked account was less
than the required minimum of $500,000. As such, we are not in
compliance with the required current ratio and accounts payable financial
covenants and have not complied with the requirement to maintain a minimum
of $500,000 in the blocked account. We have requested a waiver
for these events of noncompliance. If we are unable to obtain a
waiver of such noncompliance, DMRJ may declare the entire unpaid principal
balance, together with all interest accrued thereon, plus fees and expenses, due
and payable. Any such action on the part of DMRJ would have a
material adverse effect on our liquidity and financial condition and could force
us to curtail or discontinue all of our operations and/or file for protection
under bankruptcy laws.
On July
1, 2009, we entered into an amendment to the December 10, 2008 note and warrant
purchase agreement with DMRJ, pursuant to which we issued a senior secured
promissory note to DMRJ in the principal amount of $1,000,000.
The note
bears interest at the rate of 2.5% per month. The principal balance of the note,
together with all outstanding interest and all other amounts owed under the
note, will be due and payable on the earlier of (i) December 10, 2009 and (ii)
the receipt by us of net proceeds of at least $3,000,000 from the issuance of
debt and/or equity securities in one or more transactions. In addition, at our
option, DMRJ may require us to prepay such amounts upon (i) certain
consolidations, mergers and business combinations involving us; (ii) the sale or
transfer of more than 50% of our assets, other than inventory sold in the
ordinary course of business, in one or more related or unrelated transactions;
or (iii) the issuance by us, in one or more related or unrelated transactions,
of any equity securities or securities convertible into equity securities (other
than options granted to employees and consultants pursuant to employee benefit
plans approved by our Board of Directors), which results in net cash proceeds to
us of more than $500,000; provided however, that DMRJ may not require us to
prepay more than the net cash proceeds of
-33-
any
transaction described in the preceding clause (iii) of this sentence. We may
prepay all or any portion of the principal amount of the note, without penalty
or premium, after prior notice to DMRJ.
The
amendment to the loan agreement provides that, in the event we have not obtained
net proceeds from the issuance of debt or equity securities upon terms and
conditions acceptable to DMRJ in its sole discretion of (i) $1,000,000 by
July 24, 2009 and (ii) to the extent that we satisfied such requirements, an
additional $2,000,000 by August 21, 2009, we will immediately engage in a sale
process satisfactory to DMRJ in its sole discretion by implementing a
contingency plan which may be established by DMRJ, including, without
limitation, the engagement at our expense of a third party investment banker
acceptable to DMRJ in its sole discretion. We did not satisfy these
requirements and in August 2009, we engaged Pickwick Capital Partners to market
our Company for sale.
In
connection with the additional note issued on July 1, 2009, we also issued
871,763 shares of our Series F Convertible Preferred Stock to DMRJ, and agreed
that, if we were unable to obtain net proceeds of at least $3,000,000 from the
issuance of debt and/or equity securities by August 31, 2009, we would issue
774,900 additional shares of Series F Preferred Stock to DMRJ. DMRJ later
extended this deadline until October 1, 2009. We did not satisfy this
requirement and, on October 1, 2009, we issued such additional shares to DMRJ.
All of the 1,646,663
shares of Series F Preferred Stock held by DMRJ are convertible into 25%
of our common stock, calculated on a fully diluted basis. In addition, for so
long as the note or the amended and restated senior secured convertible
promissory note issued to DMRJ as of December 10, 2008 remain outstanding, we
may not issue additional shares of common stock, or other securities convertible
into or exercisable for common stock, if such securities would increase the
number of shares of our common stock, calculated on a fully diluted basis, unless we simultaneously
issue to DMRJ that number of additional shares of Series F Preferred Stock which
is necessary to result in the number of shares of common stock into which the
Series F Preferred Stock held by DMRJ may be converted representing the same
percentage ownership of us on a fully diluted basis after such issuance as
immediately prior thereto.
After the
repayment in full of the promissory notes, described above, the number of shares
of common stock into which the Series F Preferred Stock is convertible will
remain subject to “full ratchet” antidilution protection in the event that we
issue additional shares of common stock (or securities convertible into or
exercisable for additional shares of Common Stock) at a price below $.08 per
share. “Full ratchet” antidilution protection completely protects an investor’s
investment from subsequent price erosion until the occurrence of a liquidity
event. The anti-dilution protection will not apply, however, to issuances of
stock and options to our employees, directors, consultants and advisors pursuant
to any equity compensation plan approved by our stockholders.
The
Series F Preferred Stock is entitled to participate on an “as converted” basis
in all dividends or distributions declared or paid on our common stock. In the
event of any liquidation, dissolution or winding up of our Company, the holders
of the Series F Preferred Stock will be entitled to be paid an amount equal to
$.08 per share of Series F Preferred Stock, plus any declared but unpaid
dividends, prior to the payment of any amounts to the holders of our Series E
Convertible Preferred Stock or common stock by reason of their ownership of such
stock.
The
holders of the Series F Preferred Stock have no voting rights except as required
by applicable law. However, without the consent of the holders of a majority of
the Series F Preferred Stock, we may not (i) amend, alter or repeal any
provision of our Amended and Restated Articles of Organization or By-laws in a
manner that adversely affects the powers, preferences or rights of the Series F
Preferred Stock; (ii) authorize or issue any equity securities (or any equity or
debt securities convertible into equity securities) ranking prior and superior
to the Series F Preferred Stock with respect to dividends, distributions,
redemption rights or rights upon liquidation, dissolution or winding up; or
(iii) consummate any capital reorganization or reclassification of any of our
equity securities (or debt securities convertible into equity securities) into
equity securities ranking prior and superior to the Series F Preferred Stock
with respect to dividends, distributions, redemption rights or rights upon
liquidation, dissolution or winding up.
On August
5, 2009, we entered into a second amendment to the December 10, 2008 note and
warrant purchase agreement with DMRJ, pursuant to which we issued DMRJ
a bridge note in the principal amount of $700,000. The note
bears interest at the rate of 25% per annum. The principal balance of the note,
together with all outstanding interest and all other amounts owed under the
note, was due and payable on August 17, 2009. The outstanding
principal balance and interest due under this bridge note was paid on September
4, 2009.
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On
September 4, 2009, we entered into an additional credit agreement with DMRJ,
pursuant to which DMRJ provided us with a revolving line of credit in the
maximum principal amount of $3,000,000. In connection with the credit agreement,
we issued a promissory note to DMRJ evidencing our obligations under the credit
facility. Each of our subsidiaries guaranteed our obligations under the credit
facility. Our obligations and our subsidiaries' obligations are secured by
grants of first priority security interests in all of our respective assets. In
addition, we agreed to cause all of our receivables and collections to be
deposited in a bank deposit account pledged to DMRJ pursuant to a blocked
account agreement. All funds deposited in the blocked collections account will
be applied towards the repayment of our obligations to DMRJ under the note.
Until the note and all of our obligations thereunder have been paid and
satisfied in full, we will have no right to access or make withdrawals from the
blocked account without DMRJ’s consent.
The note
bears interest at the rate of 25% per annum. Interest under the note will be due
on the first day of each calendar month. The principal balance of the note,
together with all outstanding interest and all other amounts owed under the
note, will be due and payable on December 10, 2009. We may prepay all or any
portion of the principal amount of the note, without penalty or premium, after
prior notice to DMRJ. Subject to applicable cure periods, amounts due under the
note are subject to acceleration upon certain events of default, including: (i)
any failure to pay when due any amount owed under the note; (ii) any failure to
observe or perform any other condition, covenant or agreement contained in the
note or certain conditions, covenants or agreements contained in the credit
agreement; (iii) certain suspensions of the listing or trading of our common
stock; (iv) a determination that any misrepresentation made by us to DMRJ
in the credit agreement or in any of the agreements delivered to DMRJ in
connection with the credit agreement were false or incorrect in any material
respect when made; (v) certain defaults under agreements related to any of our
other indebtedness; (vi) the institution of certain bankruptcy and insolvency
proceedings by or against us; (vii) the entry of certain monetary judgments
against us that are not dismissed or discharged within a period of 20 days;
(viii) certain cessations of our business in the ordinary course; (ix) the
seizure of any material portion of our assets by any governmental authority; and
(x) our indictment for any criminal activity.
In lieu
of paying DMRJ any commitment fees, closing fees or other fees in connection
with the credit agreement, we agreed to pay DMRJ an additional amount equal to
50% of or aggregate net profits, as defined, generated between the closing date
through the termination of the credit facility. Such payments will be due and
payable as earned upon (i) each request for an advance under the note, and (ii)
the termination of the credit facility. For the period September 4,
2009 through September 30, 2009, we experienced a net loss and
no such payments were due or payable to DMRJ as of
September 30, 2009.
Upon the
closing of the credit facility, we requested and were granted an initial advance
of approximately $1,633,000, of which we used approximately $715,000 to repay
all of our outstanding indebtedness to DMRJ pursuant to the bridge note
issued to DMRJ on August 5, 2009, and approximately $548,000 to retire certain
obligations owed to other parties. We used the balance of the initial
advance for working capital and ordinary course general corporate
purposes.
As
of September 30, 2009, our obligations to DMRJ under the amended and restated
senior secured promissory note, the second senior secured promissory note and
under the credit facility approximated $4,600,000, $1,000,000 and $1,833,000,
respectively. Further, as of September 30, 2009, our obligation to
DMRJ for accrued interest under the amended senior secured promissory note and
under the credit facility approximated $108,000. All such amounts will become
due and payable on December 10, 2009. The failure to refinance this indebtedness
or otherwise negotiate extensions of our obligations to DMRJ would have a
material adverse impact on our liquidity and financial condition and could force
us to curtail or discontinue operations entirely
and/or file for protection under bankruptcy laws.
Our
ability to comply with our debt covenants in the future depends on our ability
to generate sufficient sales and to control expenses, and will require us to
seek additional capital through private financing sources. There can
be no assurances that we will achieve our forecasted financial results or that
we will be able to raise additional capital to operate our
business. Any such failure would have a material adverse impact on
our liquidity and financial condition and could force us to curtail or
discontinue operations entirely and/or file for protection under bankruptcy
laws. Further, upon the occurrence of an event of default under
certain provisions of our agreements with DMRJ, we could be required to pay
default rate interest equal to the lesser of 2.5% per month and the maximum
applicable legal rate per annum on the outstanding principal balance
outstanding.
-35-
We are
currently expending significant resources to develop the next generation of our
current products and to develop new products. Although we continue to
fund as much research and development as possible through government grants and
contracts in accordance with the provisions of the respective grant awards, we
will require additional funding in order to continue the advancement of the
commercial development and manufacturing of the explosives detection
system. We will attempt to obtain such financing by: (i) government
grants, (ii) private financing, or (iii) strategic
partnerships. However, there can be no assurance that we will be
successful in our attempts to raise such additional financing.
We will
require substantial funds for further research and development, regulatory
approvals, and the marketing of our explosives detection
products. Our capital requirements depend on numerous factors,
including but not limited to the progress of our research and development
programs; the cost of filing, prosecuting, defending and enforcing any
intellectual property rights; competing technological and market developments;
changes in our development of commercialization activities and
arrangements; the hiring of additional personnel, and acquiring capital
equipment.
Based on
the current sales, expense and cash flow projections, advances on our line of
credit, proceeds from certain expected sales of assets, and the ability to raise
additional capital, management believes it has plans in place to fund operations
through December 10, 2009 and, if we are successful in refinancing our
obligations to DMRJ, for the near future. If we are successful
in refinancing these obligations, there can still be no assurances
that sales will materialize as forecasted, management will be
successful in executing its business plan and/or any capital we
raise will be sufficient to fund operations indefinitely.
Management will therefore continue to closely monitor and attempt to
control our costs and will continue to actively seek the needed capital through
government grants and awards, strategic alliances, private financing sources,
and through our lending institutions. Future expenditures for
research and product development are discretionary and can be adjusted, as can
certain selling, general and administrative expenses, based on the availability
of cash. The financial statements do not include any adjustments
relating to the recoverability and classification of asset amounts or the
amounts and classification of liabilities that might be necessary should we be
unable to continue as a going concern.
Off-Balance
Sheet Arrangements
As of
September 30, 2009 we had an irrevocable standby letter of credit outstanding in
the approximate amount of $418,000. The letter of credit provides
performance security equal to 10% of the contract amount for product shipped in
the first quarter of fiscal 2009. The letter of credit expires on
July 31, 2010.
As of
September 30, 2009, we did not have any other off-balance sheet arrangements
that have, or are reasonably likely to have, a current or future material effect
on our condensed consolidated financial condition, results of operations,
liquidity, capital expenditures or capital resources.
New
Accounting Pronouncements
In June
2009, the Financial Accounting Standards Board ("FASB") issued Statement of
Financial Accounting Standards No. 168, “The FASB Accounting Standards
Codification and the
Hierarchy of Generally Accepted Accounting Principles (“GAAP”)”, a replacement of FASB Statement No.
162 (“SFAS 168”). SFAS 168 establishes the FASB Accounting
Standards Codification as the single source of authoritative generally
accepted accounting principles in the United States ("GAAP"), other than
rules and interpretive releases issued by the Securities and Exchange
Commission. The Codification is a reorganization of current GAAP into a
topical format that eliminates the current GAAP hierarchy and establishes
instead two levels of guidance — authoritative and nonauthoritative. All
non-grandfathered, non-SEC accounting literature that is not included in the
Codification will become nonauthoritative. The FASB’s primary goal in developing
the Codification is to simplify user access to all authoritative GAAP by
providing all the authoritative literature related to a particular accounting
topic in one place. The Codification is effective for interim and annual periods
ending after September 15, 2009. Following SFAS 168, the FASB
will not issue new standards in the form of Statements, FASB Staff Positions, or
Emerging Issue Task Force Abstracts; instead, it will issue Accounting Standards
Updates. The FASB will not consider Accounting Standards Updates as
authoritative in their own right; these updates will serve only to update the
Codification, provide background information about the guidance, and provide the
bases for conclusions on the change(s) in the Codification. In the
description of Accounting Standards Updates that follows, references in
“italics” relate to Codification Topics and Subtopics, and their descriptive
titles, as appropriate.
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Accounting
Standards Updates—In June 2009, an update was made to “Consolidation — Consolidation
of Variable Interest Entities.” Among other things, the update
replaces the calculation for determining which entities, if any, have a
controlling financial interest in a variable interest entity (VIE) from a
quantitative based risks and rewards calculation, to a qualitative approach that
focuses on identifying which entities have the power to direct the activities
that most significantly impact the VIE’s economic performance and the obligation
to absorb losses of the VIE or the right to receive benefits from the VIE. The
update also requires ongoing assessments as to whether an entity is the primary
beneficiary of a VIE (previously, reconsideration was only required upon the
occurrence of specific events), modifies the presentation of consolidated VIE
assets and liabilities, and requires additional disclosures about a company’s
involvement in VIEs. This update will be effective for fiscal years beginning
after November 15, 2009. We do not currently believe that the adoption of
this update will have any effect on our consolidated financial position and
results of operations.
In
September 2009, an update was made to “Fair Value Measurements and
Disclosures — Investments in Certain Entities that Calculate Net Asset
Value per Share (or Its Equivalent).” This update permits entities
to measure the fair value of certain investments, including those with fair
values that are not readily determinable, on the basis of the net asset value
per share of the investment (or its equivalent) if such net asset value is
calculated in a manner consistent with the measurement principles in “Financial Services-Investment
Companies” as of the reporting entity’s measurement date (measurement of
all or substantially all of the underlying investments of the investee in
accordance with the “Fair
Value Measurements and Disclosures” guidance). The update also requires
enhanced disclosures about the nature and risks of investments within its scope
that are measured at fair value on a recurring or nonrecurring basis. This
update will be effective for interim and annual periods ending after
December 15, 2009. We are currently evaluating the effect that adoption of
this update will have, if any, on our consolidated financial position and
results of operations.
In
October 2009, an update was made to “Revenue Recognition —
Multiple Deliverable Revenue Arrangements.” This update removes the
objective-and-reliable-evidence-of-fair-value criterion from the separation
criteria used to determine whether an arrangement involving multiple
deliverables contains more than one unit of accounting, replaces references to
“fair value” with “selling price” to distinguish from the fair value
measurements required under the “Fair Value Measurements and
Disclosures” guidance, provides a hierarchy that entities must use to
estimate the selling price, eliminates the use of the residual method for
allocation, and expands the ongoing disclosure requirements. This update is
effective for fiscal years beginning on or after June 15, 2010, and can be
applied prospectively or retrospectively. We are currently evaluating the effect
that adoption of this update will have, if any, on our consolidated financial
position and results of operations.
Quantitative
and Qualitative Disclosures About Market
Risk.
|
Not
required pursuant to Item 305(e) of Regulation S-K.
Controls
and Procedures
|
The
certifications of our Chief Executive Officer and Chief Financial Officer
attached as Exhibits 31.1 and 31.2 to this Annual Report on Form 10-Q include,
in paragraph 4 of such certifications, information concerning our disclosure
controls and procedures, and internal control over financial
reporting. Such certifications should be read in conjunction with the
information contained in this Item 4T for a more complete understanding of the
matters covered by such certifications.
Disclosure
Controls and Procedures
Our
management, with the participation of our Chief Executive Officer and Chief
Financial Officer, evaluated the effectiveness of our disclosure controls and
procedures as of September 30, 2009. The term “disclosure controls
and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the
Securities Exchange Act of 1934, means controls and other procedures of a
company that are designed to ensure that information required to be disclosed by
the company in the reports that it files or submits under the Exchange Act is
recorded, processed, summarized, and reported, within the time periods specified
in the rules and forms of the Securities and Exchange
Commission. Disclosure controls and procedures include, without
limitation, controls and procedures designed to ensure that information required
to be disclosed by a company in the reports that it files or submits under the
Exchange Act is accumulated and communicated to the company’s management,
including its Chief Executive Officer and Chief Financial Officer, as
appropriate, to allow timely decisions to be made regarding required
disclosure. It should be noted that any system of controls and
procedures, however well designed and operated, can provide only reasonable, and
not absolute, assurance that the objectives of the system are met and that
management necessarily applies its
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judgment
in evaluating the cost-benefit relationship of possible controls and
procedures. Based on the evaluation of our disclosure controls and
procedures as of September 30, 2009, our Chief Executive Officer and Chief
Financial Officer concluded that, as of such date, our disclosure controls and
procedures were effective at the reasonable assurance level.
Changes
in Internal Control Over Financial Reporting
There
were no changes to our internal control over financial reporting during the
quarter ended September 30, 2009 that have materially affected, or are
reasonably likely to materially affect, our internal control over financial
reporting.
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PART
II. OTHER
INFORMATION
Legal
Proceedings
|
From time
to time, we are subject to various claims, legal proceedings and investigations
covering a wide range of matters that arise in the ordinary course of our
business activities. Each of these matters is subject to various
uncertainties.
In
conjunction with the May 2007 sale of our Accurel business to Evans Analytical,
Accurel entered into a sublease of its facility to Evans. In April
2009, Silicon Valley CA-I, LLC, the lessor of such property to Accurel, filed
suit against Accurel and Evans in the Superior Court of the State of California,
County of Santa Clara, alleging nonpayment of rent. On June 24, 2009, Accurel
and Evans entered into a release and settlement agreement with the lessor, under
the terms of which Accurel was required to pay $224,840, representing the
amounts that are past due under the lease, plus monthly rents owing under the
lease, less the payment that Evans is required to make under the terms of the
settlement agreement. Accurel was required to pay such amount on or
before September 4, 2009. On September 4, 2009, Accurel
remitted the settlement payment. In accordance with the release and
settlement agreement, provided that Accurel and Evans have complied with the
terms of the lease and payment in accordance with the agreement, the lessor has
agreed to dismiss the suit on or before September 14, 2009, and Accurel will
have no further obligations or liabilities to the lessor. As of November
12, 2009, the suit had not been dismissed.
Except as
disclosed under Item 3 of our Annual report on Form 10-K, as amended, for the
fiscal year ended June 30, 2009, we are not
a party to any other legal proceedings, other than ordinary routine litigation
incidental to our business, which we believe will not have a material affect on
our business, assets or results of operations.
Item
1A.
|
Risk
Factors
|
We
will be required to repay our borrowings from DMRJ Group LLC on
December 10, 2009.
We will
be required to repay all of our borrowings from DMRJ Group LLC on December 10,
2009. Our obligations to DMRJ are secured by a security interest in
substantially all of our assets. As of September 30, 2009, the
outstanding balance due to DMRJ under two senior secured promissory
notes and a revolving credit facility were $4,600,000, $1,000,000 and
$1,833,000, respectively. If we are unable to repay these amounts as
required, refinance our obligations to DMRJ, or negotiate extensions of these
obligations, DMRJ may seize our assets and we may be forced to curtail or
discontinue operations entirely and/or file for protection under bankruptcy
laws.
We
are in default of certain financial covenants related to the senior secured
promissory note issued to DMRJ Group LLC. If we are unable to obtain
a waiver from DMRJ, then DMRJ may declare the entire unpaid principal balances
of all of our obligations to DMRJ, together with all interest accrued thereon,
plus fees and expenses, due and payable.
As of
September 30, 2009 we were not in compliance with certain financial covenants in
our senior secured convertible promissory note payable to DMRJ. We
have requested a waiver for these defaults. If we do not receive this waiver, or
if we are unable to comply with the financial covenants to DMRJ in
the future and if we are unable to obtain a waiver of any such noncompliance, we
could be required to pay interest at a default rate equal to the lesser of 2.5%
per month and the maximum applicable legal rate per annum on the outstanding
principal balance of our obligations. In addition, DMRJ may declare
the entire unpaid principal balance of our obligations to it, together with all
interest accrued thereon, plus fees and expenses, due and
payable. Any such action on the part of DMRJ would have a material
adverse effect on our liquidity and financial condition and could force us to
curtail or discontinue all of our operations and/or file for protection under
bankruptcy laws.
We
will require additional capital to fund operations and continue the development,
commercialization and marketing of our product. Our failure to raise
capital could have a material adverse effect on the business.
Management
continually evaluates plans to reduce our operating expenses, increase sales and
increase our cash flow from operations. Despite our current
sales, expense and cash flow projections, we will require additional capital in
the second quarter of fiscal 2010 to fund operations and continue the
development, commercialization and marketing of our products. Our
failure to achieve our projections and/or obtain sufficient additional capital
on acceptable terms, would have a material adverse effect on our liquidity and
operations and could require us to file for protection under bankruptcy
laws.
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Item
2.
|
Unregistered
Sales of Equity Securities and Use of
Proceeds
|
On July
1, 2009 and October 1, 2009, we issued 871,763 and 774,900 shares of Series F
Convertible Preferred Stock, respectively, to DMRJ Group LLC, pursuant to the
First Amendment, dated July 1, 2009, to the Note and Warrant Purchase Agreement
dated December 10, 2008. The issuance of these shares was exempt from
registration under the Securities Act of 1933, as amended, pursuant to an
exemption provided by Section 4(2) of the Securities Act.
Defaults
Upon Senior Securities
|
As of
September 30, 2009 we were in violation of certain financial covenants under our
senior secured convertible promissory note agreement DMRJ Group,
LLC. The covenants related to a minimum current ratio, an
accounts payable financial covenant and have not complied with the requirement
to maintain a minimum of $500,000 in the blocked account. We have
requested a waiver for these covenant violation, however, we cannot be certain
that a waiver will be granted. As of November 12, 2009, our
obligation under the senior secured promissory note and line of credit amounted
$4,600,000, $1,000,000 and $2,127,000.
Submission
of Matters to a Vote of Security
Holders
|
None.
Other
Information
|
None.
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Item
6.
|
Exhibits
|
Exhibit
No.
|
10.1
(1)
|
Credit
Amendment, dated September 4, 2009, among Implant Sciences Corporation, C
Acquisition Corp., Accurel Systems International Corporation, IMX
Acquisition Corp. and DMRJ Group
LLC.
|
|
10.2
(1)
|
Promissory
Note, dated September 4, 2009, in the maximum principal amount of
$3,000,000, issued by Implant Sciences Corporation to DMRJ Group
LLC.
|
|
10.3
(1)
|
Security
Agreement, dated as of September 4, 2009, among Implant Sciences
Corporation, C Acquisition Corp., Accurel Systems International
Corporation and IMX Acquisition Corp., as grantors, and DMRJ Group LLC, as
secured party.
|
|
10.4
(1)
|
Patent
Security Agreement, dated as of September 4, 2009, among Implant Sciences
Corporation, C Acquisition Corp., Accurel Systems International
Corporation and IMX Acquisition Corp., as grantors, and DMRJ Group LLC, as
secured party.
|
|
10.5
(1)
|
Guaranty,
dated as of September 4, 2009, of the obligations of Implant Sciences
Corporation by C Acquisition Corp., Accurel Systems International
Corporation and IMX Acquisition Corp. in favor of DMRJ Group
LLC.
|
|
10.6
(2)
|
First
Amendment, dated July 1, 2009, to Note and Warrant Purchase Agreement,
dated as of December 10, 2008, between Implant Sciences Corporation and
DMRJ Group LLC.
|
|
10.7
(2)
|
Senior
Secured Promissory Note, dated July 1, 2009, in the principal amount of
$1,000,000, issued by Implant Sciences Corporation to DMRJ Group
LLC.
|
|
10.8
(2)
|
Security
Agreement, dated as of December 10, 2008, among Implant Sciences
Corporation, C Acquisition Corp., Accurel Systems International
Corporation and IMX Acquisition Corp., as grantors, and DMRJ Group LLC, as
secured party.
|
|
10.9
(2)
|
Patent
Security Agreement, dated as of December 10, 2008, among Implant Sciences
Corporation, C Acquisition Corp., Accurel Systems International
Corporation and IMX Acquisition Corp., as grantors, and DMRJ Group LLC, as
secured party.
|
|
10.10
(2)
|
Guaranty,
dated as of December 10, 2008, of the obligations of Implant Sciences
Corporation by C Acquisition Corp., Accurel Systems International
Corporation and IMX Acquisition Corp. in favor of DMRJ Group
LLC.
|
|
31.1 (3)
|
Certification
of Principal Executive Officer pursuant to Section 3.02 of the
Sarbanes-Oxley Act of 2002.
|
|
31.2
(3)
|
Certification
of Principal Financial Officer pursuant to Section 3.02 of the
Sarbanes-Oxley Act of 2002.
|
|
32.1
(3)
|
Certification
of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
|
|
32.2
(3)
|
Certification
of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
|
______________________
(1)
Filed as an Exhibit to Implant Sciences Corporation’s Form
8-K dated September 4, 2009 and filed September 11, 2009.
(2)
Filed as an Exhibit to Implant Sciences Corporation’s Form
8-K dated July 1, 2009 and filed July 8, 2009.
(3)
Filed herewith.
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SIGNATURES
Pursuant
to the requirements of the Securities Exchange Act of 1934, the registrant has
duly caused this report to be signed on our behalf by the undersigned thereunto
duly authorized.
Implant
Sciences Corporation
By: /s/ Glenn D.
Bolduc
Glenn D.
Bolduc
President,
Chief Executive Officer and Chief Financial Officer
Dated: November
13, 2009
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