Attached files
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] Quarterly Report under Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the quarterly period ended December 31, 2009
[ ] Transition Report under Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the transition period ____________ to ____________
Commission File Number 000-49735
INTRAOP MEDICAL CORPORATION
(Exact name of registrant as specified in its charter)
Nevada 87-0642947
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
570 Del Rey Avenue
Sunnyvale, California 94085
(Address of principal executive offices)
Issuer's telephone number, including area code: 408-636-1020
Not applicable
(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 issuer was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days.
[X] Yes [ ] No
Indicate by check mark whether the registrant has submitted electronically and
posted on its corporate Web site, if any, every Interactive Data File required
to be submitted and posted pursuant to Rule 405 of Regulation S-T ( 232.405 of
this chapter) during the preceding 12 months (or for such shorter period that
the registrant was required to submit and post such files).
[ ] Yes [ ] No
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
the definitions of "large accelerated filer," "accelerated filer" and "smaller
reporting company" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer |_| Accelerated filer |_|
Non-accelerated filer |_| Smaller reporting company |x|
(Do not check if a 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 [X] No
State the number of shares outstanding of each of the issuer's classes of common
stock, as of the latest practicable date: 7,855,894 shares of $0.001 par value
Common Stock outstanding as of the date of this filing.
INTRAOP MEDICAL CORPORATION
FORM 10-Q
TABLE OF CONTENTS
PART 1 - FINANCIAL INFORMATION.................................................4
Item 1. Financial Statements................................................4
Item 2. Management's Discussion and Analysisof Financial Condition
and Results of Operations...........................................4
Item 3. Quantitative and Qualitative Disclosures About Market Risk.........15
Item 4. Controls and Procedures............................................15
PART II - OTHER INFORMATION...................................................16
Item 1. Legal Proceedings..................................................16
Item 1a. Risk Factors.......................................................16
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds........28
Item 3. Defaults upon Senior Securities....................................29
Item 4. Submission of Matters to a Vote of Security Holders................29
Item 5. Other Information..................................................29
Item 6. Exhibits...........................................................29
SIGNATURES....................................................................30
INDEX TO FINANCIAL STATEMENTS................................................Q-1
3
PART 1 - FINANCIAL INFORMATION
Item 1. Financial Statements
The accompanying unaudited financial statements, listed on the index to
financial statements on page Q-1 and filed as part of this Form 10-Q, have been
prepared in accordance with the instructions to Form 10-Q and, therefore, do not
include all information and footnotes necessary for a complete presentation of
financial position, results of operations, cash flows, and stockholders' deficit
in conformity with generally accepted accounting principles. In the opinion of
management, all adjustments considered necessary for a fair presentation of the
results of operations and financial position have been included and all such
adjustments are of a normal recurring nature. Operating results for the three
months ended December 31, 2009 are not necessarily indicative of the results
that can be expected for the year ending September 30, 2010.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
This discussion and analysis should be read in conjunction with our audited
financial statements and accompanying footnotes included in our Form 10-K in
which we disclosed our financial results for the years ended September 30, 2009
and 2008 and such other reports as we file from time to time with the SEC.
This section contains forward-looking statements. These forward-looking
statements involve a number of risks and uncertainties, including those
identified in the section of this Form 10-Q titled "Risk Factors" that may cause
actual results to differ materially from those discussed in, or implied by, such
forward-looking statements. Forward-looking statements within this Form 10-Q are
identified by words such as "believes," "anticipates," "expects," "intends,"
"may," and other similar expressions. However, these words are not the only
means of identifying such statements. In addition, any statements that refer to
expectations, projections or other characterizations of future events or
circumstances are forward-looking statements. We are not obligated and expressly
disclaim any obligation to publicly release any update to any forward-looking
statement. Actual results could differ materially from those anticipated in, or
implied by, forward-looking statements as a result of various factors, including
the risks outlined elsewhere in this report.
Business Overview
Intraop Medical Corporation, or the Company, was incorporated in Nevada on
November 5, 1999. Our business is the development, manufacture, marketing,
distribution and service of the Mobetron, a proprietary mobile electron-beam
cancer treatment system designed for use in intraoperative electron-beam
radiation therapy, or IOERT. Although intraoperative radiation therapy may be
delivered using a radiation source other than electrons, we use the term IOERT
to mean both intraoperative radiation therapy in general and, in the case of the
Mobetron, specifically intraoperative electron-beam radiation therapy. The
IOERT procedure involves the direct application of radiation to a tumor and/or
tumor bed while a patient is undergoing surgery for cancer. The Mobetron is
designed to be used without additional shielding in the operating room, unlike
conventional equipment adopted for the IOERT procedure. The Mobetron can be
moved from operating room to operating room, thereby increasing its utilization
and cost effectiveness. In addition to IOERT, the Mobetron also can be used as a
conventional radiotherapy electron-beam accelerator.
4
Our growth strategy is to expand our customer base both in the United
States and internationally through direct and distributor sales channels and
joint ventures with health care providers. We also intend to continue our
research and development efforts for additional Mobetron applications and cost
reduction.
We derive revenues from Mobetron product and accessory sales, service and
support, and leases. Product sales revenue is recognized upon shipment, provided
that any remaining obligations are inconsequential or perfunctory and collection
of the receivable is deemed probable. Revenue from lease activities, if any, is
recognized as income over the lease term as it becomes receivable according to
the provisions of the lease. Revenue from maintenance is recognized as services
are completed or over the term of the service agreements, as more fully
disclosed in our financial statements.
Costs of revenue consists primarily of amounts paid to contact
manufacturers, salary and benefit costs for employees performing customer
support and installation, lease related interest expense and depreciation
related to leased assets. General and administrative expenses include among
other things, the salaries and benefits of our executive and administrative
personnel, communications, facilities, insurance, professional services and
other administrative expenses. Sales and marketing expenses include salaries,
benefits and the related expenses of our sales staff such as travel expenses,
promotion materials, conferences and seminars. Research and development expenses
consist primarily of compensation and related direct costs for our employees and
an allocation of research and development-related overhead expenses. These
amounts have been primarily invested in development of the Mobetron and have
been expensed as they have been incurred.
As the Mobetron, our primary product, has a list price of approximately
$1.5 million, and given our current low unit sales volume, our historical
results may vary significantly from period to period. For example, the sale of
one additional Mobetron in any given period may substantially alter the sales
and cost numbers for that period, while the timing of such a sale often cannot
be predicted with accuracy. While we expect that our financial results may
ultimately become more predictable as sales increase and costs stabilize, our
financial results for the foreseeable future are likely to continue to vary
widely from period to period.
Critical Accounting Policies
This discussion and analysis of financial condition and results of
operation is based on our financial statements, which were prepared in
conformity with accounting principles generally accepted in the United States.
The preparation of these financial statements requires our management to make
estimates and assumptions that affect the reported amounts of assets,
liabilities, revenues and expenses. These estimates and assumptions are based
on historical experience and on various other factors that our managements
believes are reasonable under the circumstances, the results of which form the
basis for making judgments about the carrying values of assets and liabilities
that are not readily apparent from other sources. These estimates and
assumptions also require the application of certain accounting policies, many of
which require estimates and assumptions about future events and their effect on
amounts reported in the financial statements and related notes. We periodically
review our accounting policies and estimates and make adjustments when facts and
circumstances dictate. Actual results may differ from these estimates under
different assumptions or conditions. Any differences may have a material impact
on our financial condition and results of operation.
We believe that the following accounting policies fit the definition of
critical accounting policies. We use the specific identification method to set
reserves for both doubtful accounts receivable and the valuation of our
inventory, and use historical cost information to determine our warranty
reserves. Further, in assessing the fair value of option and warrant grants, we
have valued these instruments based on the Black-Scholes model, which requires
estimates of the volatility of our stock and the market price of our shares,
which, when there was no public market for shares, was based on estimates of
fair value made by our Board of Directors.
5
Share-based Compensation Expense
Effective January 1, 2006, we adopted the modified prospective transition
method under Accounting Standards Codification ("ASC") 718-10 (previously
Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based
Payment, or SFAS 123(R)), which requires the measurement and recognition of
compensation expense for all share-based payment awards made to employees and
directors, including stock options issued under our 2005 Equity Incentive Plan.
Upon adoption of ASC 718-10, we elected to value our share-based payment awards
granted after January 1, 2006 using the Black-Scholes option-pricing model, or
the Black-Scholes model, which we previously used for the pro forma information
required under ASC 718-10. For additional information, see Note 7 to the audited
Consolidated Financial Statements.
The Black-Scholes model was developed for use in estimating the fair value
of traded options that have no vesting restrictions and are fully transferable.
The Black-Scholes model requires the input of certain assumptions. Our options
have characteristics significantly different from those of traded options, and
changes in the assumptions can materially affect the fair value estimates. The
determination of the fair value of share-based payment awards on the date of
grant using the Black-Scholes model is affected by our stock price as well as
the input of other subjective assumptions. These assumptions include, but are
not limited to, the expected term of stock options and our expected stock price
volatility over the term of the awards.
The expected term of stock options represents the weighted-average period
the stock options are expected to remain outstanding. The expected term is based
on the observed and expected time to post-vesting exercise and forfeitures of
options by our employees. Upon the adoption of ASC 718-10, we determined the
expected term of stock options using the simplified method as allowed under ASC
718-10 (previously Staff Accounting Bulletin 107, or SAB 107). Prior to January
1, 2006, we determined the expected term of stock options based on the option
vesting period. Upon adoption of ASC 718-10, we used historical volatility
measured over a period equal to the options' expected terms in deriving their
expected volatility assumption as allowed under ASC 718-10. Prior to January 1,
2006, we had also used our historical stock price volatility in accordance with
ASC 718-10 for purposes of our pro forma information. The risk-free interest
rate assumption is based upon observed interest rates appropriate for the term
of our stock options. The dividend yield assumption is based on our history and
expectation of dividend payouts.
As share-based compensation expense recognized in our financial statements
is based on awards ultimately expected to vest, it has been reduced for
estimated forfeitures. ASC 718-10 requires forfeitures to be estimated at the
time of grant and revised, if necessary, in subsequent periods if actual
forfeitures differ from those estimates. Forfeitures were estimated based on our
historical experience. In our pro-forma information required under ASC 718-10
for the periods prior to January 1, 2006, we accounted for forfeitures as they
occurred. If factors change and we employ different assumptions in the
application of ASC 718-10 in future periods, the compensation expense that we
record under ASC 718-10 may differ significantly from what we have recorded in
the current period.
As of December 31, 2009, there was approximately $194,508 of total
unrecognized compensation expense related to stock options granted under our
2005 Equity Incentive Plan. This unrecognized compensation expense is expected
to be recognized over a weighted average period of 1.5 years.
6
Results of Operation for the three months ended December 31, 2009 compared
to the three months ended December 31, 2008.
Revenue, Costs of Revenue and Gross Margins
Three months ended December 31,
Revenue 2009 2008 Change Percent
-------------------------------------------- ---------------- ------------------ ------------
Product sales $ 4,637 $ 1,093,619 $ (1,088,982) -100%
Leasing 45,000 - 45,000 100%
Service 111,429 104,647 6,782 6%
-------------------------------------------- ---------------- ------------------ ------------
Total Revenue $ 161,066 $ 1,198,266 $ (1,037,200) -87%
-------------------------------------------- ---------------- ------------------ ------------
Costs of Revenue
-------------------------------------------- ---------------- ------------------ ------------
Product sales $ 49,407 $ 994,261 $ (944,854) -95%
Leasing 55,448 - 55,448 100%
Service 44,427 49,565 (5,138) -10%
-------------------------------------------- ---------------- ------------------ ------------
Total Costs of Revenue $ 149,282 $ 1,043,826 $ (894,544) -86%
-------------------------------------------- ---------------- ------------------ ------------
Three months ended December 31,
Gross Margin 2009 2008 Change Percent
-------------------------------------------- ---------------- ------------------ ------------
Product sales $ (44,770) $ 99,358 $ (144,128) -145%
-965% 9%
Leasing (10,448) - (10,448) -100%
-23%
Service 67,002 55,082 11,920 22%
60% 53%
-------------------------------------------- ---------------- ------------------ ------------
Total Gross Margin $ 11,784 $ 154,440 $ (142,656) -92%
7% 13%
============================================ ================ ================== ============
Product Sales
Product sales revenue includes systems and accessories sales, but excludes
parts sold as part of our service business. During the three months ended
December 31, 2009, we recognized zero Mobetrons sold compared to one Mobetron
sold during the three months ended December 31, 2008, maintaining our total
installed Mobetron base worldwide at thirty systems.
7
Leasing Revenue
Leasing revenue for the fiscal year ended December 31, 2009 was $45,000
compared to none recognized in the three months ended December 31, 2008. This
revenue was generated in connection with our first leasing arrangement for the
placement of a Mobetron into a dermatology clinic. We anticipate further growth
in leasing revenues as we seek to expand our presence in the dermatological
market.
Pursuant to the terms of the lease, the rent for the leased Mobetron system
is $15,000 per month for up to 15 patients. For each patient above 15 in any
given month, the rent for that month is increased by $1,000 for each patient. To
date, the customer has not treated more than 15 patients in a month. Therefore,
the cost of leasing revenue is more than the revenue itself, primarily due to
the financing of leased Mobetron through a third party financier for $1,150,000
at a fixed interest rate of 12%. The interest charge is included in the cost of
revenue together with the cost of depreciation of the leased Mobetron on a
straight line basis over the expected life of 120 months.
Service
The majority of service revenue for the three months ended December 31,
2009 and December 31, 2008 came from annual service contracts, with the balance
of service revenue coming from as-requested service calls and parts sales to
customers. During the three months ended December 31, 2009 we had seven service
contracts compared to six in the three months ended December 31, 2008. We
expect service revenue to grow in relative proportion to U.S.-based sales and to
lesser extent overseas sales. Overseas distributors are generally responsible
for servicing their own customers with parts supplied by us, though we also
obtain direct contracts with a few customers in Europe, which revenue is
included in the three months ended December 31, 2009 and 2008.
Operating Expenses
A comparison of our operating expenses for the three months ended December
31, 2009 and December 31, 2008 follows:
Three months ended December 31,
2009 2008 Change Percent
---------------------------------------------------------------------------------------------
Research and Development $ 385,528 $ 410,047 $ (24,519) -6%
General & Administrative 549,081 573,222 (24,141) -4%
Sales and Marketing 470,647 758,154 (287,507) -38%
---------------------------------------------------------------------------------------------
Total Operating Expenses $ 1,405,256 $ 1,741,423 $ (336,167) -19%
=============================================================================================
Share based compensation, which consists mainly of the non-cash cost of
issuing options to our employees and directors, was $147,225 lower in the three
months ended December 31, 2009 compared to the three months ended December 31,
2008 and played a large part in decreasing operating expenses in all of the
categories shown above.
8
A comparison of our share based compensation expenses for the three months
ended December 31, 2009 and December 31, 2008 is as follows:
Share Based Compensation
Three months ended December 31,
2009 2008 Change
--------------------------------------------------- ------------------- -------------------
Research and development $ 44,964 $ 82,444 $ (37,480)
General and administrative 34,245 61,735 (27,490)
Sales and marketing 41,650 123,905 (82,255)
---------------------- ------------------- -------------------
Total $ 120,859 $ 268,084 $ (147,225)
====================== =================== ===================
Research and development expenses decreased by approximately 6% in the
three months ended December 31, 2009, in comparison to the three months ended
December 31, 2008. The majority of this decrease was due to the decreased cost
of share based compensation of $37,480 as described above, a decrease in
consulting charges of $36,372, a decrease of general maintenance and repair
expenses totaling $6,836, and a decrease in travel related costs of $5,873. All
of the above decreases were offset by $61,635 due to additional labor allocated
to research and development in line with our policy to develop in-house
production of the Mobetron. We believe that research and development expenses
will increase over time as we develop new products and applications and continue
our efforts to cut Mobetron production costs.
General and administrative expenses decreased by approximately 4% in the
three months ended December 31, 2009 compared to the three months ended December
31, 2008. The majority of this decrease was due to the decreased cost of share
based compensation of $27,490 as described above.
Sales and marketing expenses decreased by 38% in the three months ended
December 31, 2009 in comparison to the three months ended December 31, 2008. The
majority of this decrease was due to the decreased cost of share based
compensation of $82,255 as explained above. We also decreased the number of
employees and consultants from fourteen as of December 31, 2008 to ten as of
December 31, 2009. As a result the wage and personnel related expenses,
including related travel and entertainment expenses, decreased by $124,285 and
consultant fees decreased by $52,323. In addition, sales commission decreased by
$27,500 due to revamping of our commission structure during the first quarter of
fiscal year ended September 30, 2009.
Interest Expense. Our senior debentures and our product financing
arrangement represent the majority of our debt and directly affect interest
expense accordingly. Our product financing arrangement has two classes of
borrowings: borrowings related to financed inventory prior to sale to a customer
bear interest at 12% per annum while borrowings related to financed purchase
orders and receivables, or factoring, bear interest at 24% per annum.
An estimate of our new dollar weighted average borrowing rate is found
below based on the interest rates and outstanding balances of our various types
of debt, before debt discounts, at December 31, 2009 and at December 31, 2008.
9
Balance at Balance at
December 31, Interest December 31, Interest
Type of debt, net debt discounts 2009 Rate 2008 Rate
----------------------------------------------------------------------------------------------------
Notes payable, related parties $ 119,002 9.00% $ 119,002 9.00%
Product Financing Arrangement, inventory 981,056 12.00% 1,907,922 12.00%
Product Financing Arrangement, factoring 2,682,588 24.00% 2,656,320 24.00%
Lease Finance 1,150,000 12.00% 579,110 24.00%
Senior debentures 4,600,000 10.00% 2,000,000 10.00%
Other notes - 8.00% 150,000 8.00%
Other notes 44,367 9.00% 44,367 9.00%
----------------------------------------------------------------------------------------------------
Total debt, before debt discounts $ 9,577,013 $ 7,456,721
Dollar weighted average borrowing rate 14.35% 16.52%
====================================================================================================
Liquidity and Capital Resources
We experienced net losses of $2,124,860 and $1,817,022 for the three months
ended December 31, 2009 and 2008, respectively. In addition, we have incurred
substantial monetary liabilities in excess of monetary assets over the past
several years and, as of December 31, 2009, had an accumulated deficit of
$49,638,363. These matters, among others, raise substantial doubt about our
ability to continue as a going concern. In view of the matters described above,
recoverability of a major portion of the recorded asset amounts shown on our
consolidated balance sheet is dependent upon our ability to generate sufficient
sales volume to cover our operating expenses and/or to raise sufficient capital
to meet our payment obligations. Management is taking action to address these
matters, which include:
- Retaining experienced management personnel with particular skills
in the development and sale of our products and services.
- Developing new markets overseas and expanding our sales efforts
within the United States.
- Evaluating funding strategies in the public and private markets.
Historically, management has been able to raise additional capital. During
the three months ended December 31, 2009, we obtained capital through the
issuance of 10% senior secured debentures, the proceeds of which were used for
working capital and the repayment of liabilities. The successful outcome of
future activities cannot be determined at this time and there is no assurance
that if achieved, we will have sufficient funds to execute our intended business
plan or generate positive operating results.
10
Our primary cash inflows and outflows in the three months ended December 31,
2009 and 2008 were as follows:
Three months ended December 31,
Cash Flows 2009 2008 Change
--------------------------------------------------------------------------------------------
Provided by (Used in):
Operating Activities $ 81,355 $ (1,875,410) $ 1,956,763
Investing Activities (17,203) (13,081) (4,122)
Financing Activities (656,931) 1,639,459 (2,296,390)
--------------------------------------------------------------------------------------------
Net Increase/(Decrease) $ (592,779) $ (249,032) $ (343,749)
============================================================================================
Operating Activities
Net cash used for operating activities increased by $1,956,765 in the three
months ended December 31, 2009 in comparison to the three months ended December
31, 2008. Offsetting our net loss of $2,124,860 for the three months ended
December 31, 2009 were $560,374 of non-cash charges, of which $354,108 for
amortization of debt discount on warrants issued to our 10% senior secured
debenture holders and $146,176 for share based compensation. During the three
months ended December 31, 2008, our net loss of $1,817,022 was similarly offset
by non-cash charges of $379,694, primarily for stock based compensation.
Additionally, large combined differences in other asset and liability accounts
of approximately $2,083,924 between the three months ended December 31, 2009 and
2008 significantly affected operating cash flow during those two three month
periods. These accounts, which include inventories, accounts receivable,
accounts payable, customer deposits, and deposits with vendors, are currently
highly subject to short term fluctuations and will continue to be volatile
because of our low volume and timing of Mobetron sales and large per system cost
of Mobetron.
Investing Activities
The increase in investing activities in the three months ended December 31,
2009 versus the three months ended December 31, 2008, was primarily due to the
investment of $14,300 in the form of intangible assets for certain non-recurring
engineering expenses paid to third parties related development by those third
parties of certain Mobetron subsystems and $2,903 in certain long term assets
compared to $13,081 invested in long term assets during the three months ended
December 31, 2008.
Financing Activities
During the three months ended December 31, 2009, the Company borrowed
$400,000 by way of 10% senior secured debentures and repaid $200,000 to the
short term lenders. Between December 31, 2009 and 2008, the Company decreased
notes payable to revolving line of credit holders by $900,597 and also repaid
$150,000, notes payable to BTH-China were offset by the additional borrowings on
leased equipment totaled to $570,890.
11
Senior Secured Debentures
As of December 31, 2009, we had issued 10% senior secured debentures in an
aggregate principal amount of $4,600,000 to six private lenders. During January
2010, we amended the terms of such debentures and the related purchase agreement
and issued additional debentures in an aggregate principal amount of $400,000.
We may issue up to an additional $2,500,000 aggregate principal amount of such
debentures in the future under the terms of the debenture purchase agreement
that we have entered into with such lenders. As amended, these debentures
mature on the earlier of (i) July 31, 2010 or (ii) the date we close an
issuance, or series of issuances, of promissory notes convertible into shares of
our common stock with gross aggregate proceeds received by us of not less than
$8,500,000 (other than the 10% senior secured debentures). The 10% senior
secured debentures will convert at the option of the holder into shares of
capital stock in the event that we close an issuance, or series of issuances, of
shares of capital stock with gross aggregate proceeds received by us of not less
than $1,000,000 at a conversion price equal to the price per share paid by the
investors purchasing such securities. Interest on the outstanding principal
amount of the debentures accrues at 10% per annum, payable monthly. The 10%
senior secured debentures are secured by a lien on all of our assets not
otherwise pledged under our product financing arrangement.
The terms of the 10% senior secured debentures also contain restrictive
covenants that limit our ability to (i) subject to certain exceptions, create,
incur, assume, guarantee or suffer to exist indebtedness for borrowed money,
(ii) subject to certain exceptions, create, incur, assume or suffer to exist
any liens on our property or assets, (iii) amend our charter documents so as to
materially and adversely affect any rights of the debenture holders; (iv) repay,
repurchase or offer to repay, repurchase or otherwise acquire more than a de
minimis number of shares of our common stock or other equity securities; or (v)
pay cash dividends or distributions on any of our equity securities. We believe
that we are in compliance with these covenants.
Currently, we do not have sufficient capital resources to retire the 10%
senior secured debentures if the holders were to demand repayment thereof,
unless we raise additional capital as described above.
Inventory and Factoring Agreement
In August 2005, we entered into a revolving, $3,000,000, combined inventory
and factoring agreement, or product financing arrangement, under which we
pledged as collateral certain of our inventory and receivables. Pursuant to
further amendments to the product financing arrangement, as of June 30, 2009,
maximum availability under the line was $6,000,000. The product financing
arrangement has two classes of borrowings: borrowings related to financed
inventory prior to sale to a customer, which bear interest at 12% per annum
payable monthly, and borrowings related to financed purchase orders and
receivables, which bear interest at 24% per annum, payable upon receipt of
payment from customer. This agreement contains limitations on our ability to
sell, dispose of, pledge, grant an interest in, or otherwise encumber our
inventory. In addition, borrowing related to financed purchased orders must be
repaid within six (6) months.
In February 2009, we were notified by our lender under our inventory and
factoring agreements that our current purchase order financing will be
discontinued. However, they have informed us that they will continue to support
our inventory factoring, and work with any new purchase order financial
structure we develop with alternative providers. Subsequent to this notice, we
have been able to finance three purchase orders while we continue to seek a
longer term solution.
In May 2009 we reached a preliminary agreement with a new lender to
refinance our existing purchase orders as well as finance any new purchase
orders under similar terms as our previous arrangement, with outstanding amounts
bearing interest at 24% per annum. The terms of our new arrangement allowed the
lender to cancel our agreement within the first ninety (90) days in which they
have decided not to exercise. However, each new purchase order is reviewed on a
case by case basis and there is no guarantee that our new lender will continue
to finance our purchase orders. If not, we would not have adequate capital
resources to service our short term capital needs.
12
Currently, we have two financed purchase orders that have extended beyond
the 6 month limitation described above due to construction delays by the
customer preventing final acceptance. We have fulfilled our obligation under
these purchase orders, but final commissioning of these machines cannot be
completed until the operating room in which the machine will be located is
complete. We are working with the customers to secure final payment prior to
completion of the operating rooms. Currently these customers have paid 50% and
0%, respectively, against these financed purchased orders. We anticipate
resolving these payment issues in the near future. In the meantime, we do not
have sufficient capital resources to repay these financed purchase orders if the
lender were to demand repayment thereof, unless we raise additional capital or
find an alternative customer to take delivery of these units.
Debt and Lease Obligations
At December 31, 2009, we had notes payable and obligations for leased
equipment from various sources as shown below. Interest rates on such debt
range from 8% on our promissory notes to 24% on our factored receivables
financing. We also lease office space and equipment under non-cancelable
operating and capital leases with various expiration dates through 2011.
December 31,
2009
------------
Notes payable, related parties, current $ 119,002
------------
Product financing arrangement $ 3,663,644
Leased asset financing arrangement 1,150,000
Senior secured debentures 4,600,000
Other notes 44,367
------------
9,458,011
Less debt discounts due to warrants -
------------
Notes payable, net of debt discounts and beneficial conversion
features -
Less current portion (9,458,011)
------------
Notes payable, other, net of current portion, unamortized debt
discounts and beneficial conversion features $ -
============
13
As of December 31 2009, future minimum lease payments that come due in the
fiscal years ended September 30 are as follows:
Fiscal Year Ended September 30, Capital Operating
Leases Leases
--------------------------------------------------------------------------------
2010 $ 1,935 $171,016
2011 431 -
------------------
Total minimum lease payments 2,366 $171,016
=========
Less: Amount representing interest (40)
--------
Present value of minimum lease payments 2,326
Less: Current portion (2,326)
--------
Obligations under capital lease, net of current portion $ -
========
Deferred Revenue Items
Revenue under service agreements is deferred and recognized over the term
of the agreement, typically one year, on a straight line basis. As of December
31, 2009 deferred revenue was $359,236, which is included under accrued
liabilities.
Off-Balance Sheet Arrangements
We currently have no off-balance sheet arrangements.
(Remainder of page intentionally left blank)
14
Item 3. Quantitative and Qualitative Disclosures about Market Risk
We are not required to provide the information required by this Item.
Item 4. Controls and Procedures.
As of the end of the period covered by this Quarterly Report on Form
10-Q, we evaluated, under the supervision and with the participation of our
management, including our Chief Executive Officer and Chief Financial Officer,
the effectiveness of our disclosure controls and procedures, as such term is
defined under Rules 13a-15(e) and 15d-15(e) promulgated under the Securities
Exchange Act of 1934, as amended. Based upon that evaluation, our Chief
Executive Officer and Chief Financial Officer concluded that our disclosure
controls and procedures were effective to insure that information we are
required to disclose in reports that we file or submit under the Securities
Exchange Act of 1934 (i) is recorded, processed, summarized and reported within
the time periods specified in Securities and Exchange Commission rules and forms
and (ii) is accumulated and communicated to our management, including our Chief
Executive Officer and Chief Financial Officer, as appropriate, to allow timely
decision regarding required disclosure.
There has been no change in our internal control over financial
reporting during the three months ended December 31, 2009 that has materially
affected, or is reasonably likely to materially affect, our internal control
over financial reporting.
(Remainder of page intentionally left blank)
15
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
IOERT Litigation
In June 2006, we brought suit in the District Court of Dusseldorf, Germany
against Info & Tech S.p.A., an Italian company which manufactured an IOERT
system marketed as the Liac, Info & Tech's German distributor, Conmedica GmbH,
and Conmedica's manager, Mr. Seigfried Kaufhold, for infringement of the German
subpart DE69428698 of our European Patent 700578, seeking damages and an
injunction against further infringement. A ruling on the case was made on August
23, 2007 in which we prevailed in enjoining the above-named parties from selling
or distributing their product in Germany. The defendants in the case filed an
appeal on October 2, 2007. We responded to that appeal in May 2008. In September
2008, we were notified by the court that one of the defendants, Info & Tech, had
informed the court that their company was bankrupt. The proceedings continued
against the other two defendants, and a hearing was held before the Appeals
Court on December 18, 2008. The Court dismissed Info & Tech as a defendant due
to their bankruptcy and denied a petition by the remaining defendants to suspend
the infringement proceedings pending a final outcome in the nullification suit
described below.
In a related matter, on June 21, 2007, Gia-marco S.p.A., who subsequently
acquired the assets of Info & Tech following its bankruptcy, filed a proceeding
for nullification of that same German subpart DE69428698 of our European Patent
0700578 with the German Federal Patent Court. A nullification hearing determines
whether or not the patent should have been granted in the first place. If the
plaintiffs prevail in their claim then our European patent will be invalid only
in Germany, making the infringement claim moot. Our response to this filing was
made in January 2008. The court hearing on this proceeding was held on March 5,
2009, and the court ruled in favor of Gia-macro.
We have appealed the adverse ruling in the nullification proceeding and the
court of appeals in the infringement claim described above has agreed to suspend
the effectiveness of its decision pending the outcome of our appeal of the
ruling in the nullification proceeding. The German appeals court acknowledged
receiving our decision to appeal the nullification, and written briefs were
filed on November 15, 2009. No date has been set for further arguments in either
the infringement or nullification proceeding.
Alabama Securities Commission Order
On October 23, 2009, the Alabama Securities Commission issued a Cease and
Desist Order (the "Order") alleging that we knowingly allowed the unlawful
transfer of restricted stock from an individual identified in the Order, which
individual is not and has never been an employee, officer or director of
Intraop, to multiple unaccredited investors in Alabama. The Order requires that
we cease and desist from any further sales into, within, or from the State of
Alabama. We have responded to the Order within the time permitted by Alabama
law. We deny the allegations in the Order and intend to vigorously oppose the
Order and to seek its dissolution.
Item 1a. Risk Factors
This report and other information made publicly available by us from
time-to-time may contain certain forward-looking statements and other
information relating to the Company and our business that are based on the
beliefs of management and assumptions made concerning information then currently
available to management. Such statements reflect the views of management at the
time they are made and are not intended to be accurate descriptions of the
future. The discussion of future events, including the business prospects of
the Company, is subject to the material risks listed in this section and
assumptions made by management.
16
These risks include the viability of the planned market penetration that we
intend to make, our ability to identify and negotiate transactions that provide
the potential for future stockholder value, our ability to attract the necessary
additional capital to permit us to take advantage of opportunities with which we
are presented, and our ability to generate sufficient revenue such that we can
support our current and future cost structure. Should one or more of these or
other risks materialize, or if the underlying assumptions of management prove
incorrect, actual results may vary materially from those described in the
forward-looking statements. We do not intend to update these forward-looking
statements, except as may occur in the regular course of our periodic reporting
obligations.
The material risks that we believe are faced by the Company as of the date
of this quarterly report on Form 10-Q are set forth below. This discussion of
risks is not intended to be exhaustive. The risks set forth below and other
risks not currently anticipated or fully appreciated by our management could
adversely affect the business and prospects of IntraOp.
RISKS RELATING TO OUR BUSINESS
We have been in operation for over 10 years and have never been profitable.
We are a medical device company that has experienced significant operating
losses, primarily due to the cost of substantial research and development of our
primary product, the Mobetron. Since inception, we have generated about $36.6
million in revenue through December 31, 2009. However, we expect to continue to
incur operating losses as well as negative cash flow from operations in future
periods. Our ability to achieve profitability will depend upon our ability to
sell the Mobetron at higher unit volumes and at higher margins. Further, if the
Mobetron and any other of our products do not gain commercial acceptance, we may
never generate significant revenues or achieve or maintain profitability. As a
consequence of these uncertainties, our independent public accountants have
expressed a "going concern" qualification in their audit reports.
We have significant short-term and long-term capital and operating needs.
We have significant short-term and long-term capital and operating needs.
Unless we are able to raise additional capital in the near future, we will be
unable to satisfy our short-term and long-term liabilities. Equity or debt
financing sufficient to satisfy such liabilities may not be available on terms
favorable to us or at all. Our ability to raise additional capital may be
adversely affected by ongoing general financial conditions. We have spent, and
provided we are able to raise sufficient capital, will continue to spend,
substantial funds on development, marketing, research, and commercialization
related to the Mobetron and the day-to-day operation of our company. In the
past we received funds from payments by distributors and customers, proceeds
from the sale of equity securities and debt instruments, and government grants,
none of which funding may be available in the future on favorable terms or at
all.
17
We have pledged all of our assets and significant amount of the capital stock in
our subsidiaries as security for loans.
In August 2005, we entered into a revolving, $3,000,000, combined inventory
and factoring agreement, or product financing arrangement, under which we
pledged as collateral certain of our inventory and receivables. Pursuant to
further amendments to the product financing arrangement, as of December 31,
2009, maximum availability under the line was $6,000,000. As of December 31,
2009, the outstanding principal balance under the product financing arrangement
was $3,663,644.
As of January 31, 2010, we have issued 10% senior secured debentures in an
aggregate principal amount of $5,000,000 to six private accredited investors and
lenders. Among other terms, the 10% senior secured debentures are secured by a
lien on all of our assets not otherwise pledged under our product financing
arrangement. These debentures mature on the earlier of (i) July 31,2010 or (ii)
the date we close an issuance, or series of issuances, of promissory notes
convertible into shares of its common stock with gross aggregate proceeds
received by us of not less than $8,500,000. The 10% senior secured debentures
will convert at the option of the holder into shares of capital stock in the
event that we close an issuance, or series of issuances, of shares of capital
stock with gross aggregate proceeds received by us of not less than $1,000,000
at a conversion price equal to the price per share paid by the investors
purchasing such securities. Interest on the outstanding principal amount of the
debentures accrues at 10% per annum, payable monthly.
Currently, we do not have sufficient capital resources to retire the 10%
senior secured debentures when the notes mature on July 31, 2010. We will be in
default unless we can raise additional capital by July 31, 2010 or renegotiate
the terms of the 10% senior secured debenture.
Should a default occur under the product financing arrangement or the 10%
senior secured debentures, the lenders under those agreements would be entitled
to exercise their rights as secured creditors under the Uniform Commercial Code,
including the right to take possession of the pledged collateral and to sell
those assets at a public or private sale and also to sell the shares of our
subsidiaries pledged as collateral. In the event the lenders exercise those
rights, we would have a very short period of time in which to obtain adequate
capital to satisfy the amount of the obligations to the lenders to prevent the
sale of our assets. For us to obtain such capital in such a short period could
result in very significant dilution to our stockholders and if we are unable to
obtain those funds, we could be unable thereafter to operate, possibly resulting
in a total loss of the investment made by our stockholders.
We have significant additional capital and operating needs.
We have spent, and will continue to spend, substantial funds on
development, marketing, research, and commercialization related to the Mobetron
and the day-to-day operation of our company. In the past we received funds from
payments by distributors and customers, proceeds from the sale of equity
securities and debt instruments, and government grants. Any additional secured
indebtedness would require the consent of our senior lenders. Equity or debt
financing may not be available on terms favorable to us or at all, in which case
we may be unable to meet our expenses.
18
Our primary product is subject to uncertain market acceptance.
We cannot assure you that the Mobetron will gain broad commercial
acceptance or that commercial viability will be achieved, that future research
and development related to the Mobetron system will be successful or produce
commercially salable products, that other products we may develop will be
completed or commercially viable, or that hospitals or other potential customers
will be willing to make the investment necessary to purchase the Mobetron or
other products that we may develop, or be willing to comply with applicable
government regulations regarding their use.
We are currently dependent on a few key suppliers.
Following the termination of our contract manufacturing agreement with CDS
Engineering LLC in November 2008, we are dependent on two key suppliers for the
manufacturing and delivery of the accelerator guide. Accuray Incorporated
(Accuray) and XScell Corporation, both of Sunnyvale, California provide
accelerator guides to us. One of the founders of Accuray, Donald A. Goer, is
our Chief Scientist.
Any significant interruption in our relationship with Accuray, XScell
Corporation or any other supplier, including subcontractors, could have a
material adverse effect on our ability to manufacture the Mobetron and,
therefore, on our business, financial condition, and results of operation.
Further, to the extent that we are unable to negotiate favorable contract terms
or find alternate suppliers for key parts manufactured by these suppliers, we
may be subject to significant price increases for the goods purchased from these
suppliers, resulting in a decrease in product margins and profitability.
We do not have manufacturing expertise nor facilities to support a significant
increase in commercial sales.
Although members of management have extensive experience in manufacturing,
we do not have experience manufacturing our products in the volumes that will be
necessary for us to achieve significant commercial sales. We believe we have
expanded our resources to be able to assemble Mobetron to meet current
production demand. However we may encounter difficulties in scaling production
of the Mobetron or in hiring and training additional personnel to manufacture
the Mobetron in increasing quantities.
We continue to do our own final testing of the Mobetron. This testing
requires a specialized test facility. In September, 2005, we entered into a
lease for combined office, manufacturing, research and test facilities, which we
believe are adequate for testing Mobetrons through the end of the lease term in
August 2010. Should our business grow more quickly than anticipated, our
inability to locate additional test facilities or expand test facilities at our
current location would likely have a material adverse effect on our ability to
manufacture the Mobetron and, therefore, on our business, financial condition,
and results of operation.
We may be unable to protect our patents and proprietary technology.
Our ability to compete effectively in the marketplace will depend, in part,
on our ability to protect our intellectual property rights. We rely on patents,
trade secrets, and know-how to establish and maintain a competitive position in
the marketplace. The enforceability of medical device or other patents, however,
can be uncertain. Any limitation or reduction in our rights to obtain or enforce
our patents or to otherwise maintain or protect our intellectual property rights
could have a material adverse effect on our business, financial condition, and
results of operation.
19
In June 2006, we brought suit in the District Court of Dusseldorf, Germany
against Info & Tech S.p.A., an Italian company which manufactured an IOERT
system marketed as the Liac, Info & Tech's German distributor, Conmedica GmbH,
and Conmedica's manager, Mr. Seigfried Kaufhold, for infringement of the German
subpart DE69428698 of our European Patent 700578, seeking damages and an
injunction against further infringement. A ruling on the case was made on
August 23, 2007 in which we prevailed in enjoining the above-named parties from
selling or distributing their product in Germany. The defendants in the case
filed an appeal on October 2, 2007. We responded to that appeal in May 2008. In
September 2008, we were notified by the court that one of the defendants, Info &
Tech, had informed the court that their company was bankrupt. The proceedings
continued against the other two defendants, and a hearing was held before the
Appeals Court on December 18, 2008. The Court dismissed Info & Tech as a
defendant due to their bankruptcy and denied a petition by the remaining
defendants to suspend the infringement proceedings pending a final outcome in
the nullification suit described below.
In a related matter, on June 21, 2007, Gia-marco S.p.A., who subsequently
acquired the assets of Info & Tech following its bankruptcy, filed a proceeding
for nullification of that same German subpart DE69428698 of our European Patent
0700578 with the German Federal Patent Court. A nullification hearing determines
whether or not the patent should have been granted in the first place. If the
plaintiffs prevail in their claim then our European patent will be invalid only
in Germany, making the infringement claim moot. Our response to this filing was
made in January 2008. The court hearing on this proceeding was held on March 5,
2009, and the court ruled in favor of Gia-macro.
We have appealed the adverse ruling in the nullification proceeding and the
court of appeals in the infringement claim described above has agreed to suspend
the effectiveness of its decision pending the outcome of our appeal of the
ruling in the nullification proceeding. The German appeals court acknowledged
receiving our decision to appeal the nullification, and written briefs were
filed on November 15, 2009. No date has been set for further arguments in either
the infringement or nullification proceeding.
We may unknowingly infringe the intellectual property rights of third parties
and thereby be exposed to lawsuits.
We attempt to avoid infringing known proprietary rights of third parties in
our product development efforts. However, we have not conducted and do not
conduct comprehensive patent searches to determine whether the technology used
in our products infringes patents held by third parties. In addition, it is
difficult to proceed with certainty in a rapidly evolving technological
environment in which there may be numerous patent applications pending, many of
which are confidential when filed, with regard to similar technologies.
If we discover that our products violate third-party proprietary rights, we
cannot assure you that we would be able to obtain licenses to continue offering
such products without substantial reengineering or that any effort to undertake
such reengineering would be successful, that any such licenses would be
available on commercially reasonable terms, if at all, or that litigation
regarding alleged infringement could be avoided or settled without substantial
expense and damage awards. Any claims against us relating to the infringement of
third-party proprietary rights, even if not meritorious, could result in the
expenditure of significant financial and managerial resources and in injunctions
preventing us from distributing certain products. Such claims could materially
adversely affect our business, financial condition, and results of operations.
20
We could be subject to product liability claims for which we may have inadequate
insurance coverage.
The manufacture and sale of our products entails the risk of product
liability claims. Although we obtained product liability insurance prior to
commercially marketing our products, product liability insurance is expensive
and may not be available to us in the future on acceptable terms or at all. To
date, we have not experienced any product liability claims. A successful product
liability claim against us in excess of our insurance coverage could have a
material adverse affect on our business, financial condition, and results of
operation.
We are substantially dependent on certain key employees.
We believe that our success will depend to a significant extent upon the
efforts and abilities of a relatively small group of management personnel,
particularly Donald A. Goer, PhD, our Chief Scientist, and John Powers, our
President and Chief Executive Officer. The loss of the services of one or more
of these key people could have a material adverse effect on us. We have
employment agreements with Dr. Goer, and Mr. Powers and have purchased "key
person" life insurance for Dr. Goer in the amount of $5,000,000, of which
$3,000,000 has been pledged to holders of our 10% senior secured debentures as
security for our obligations under the debentures.
Our future success will also depend upon our ability to continue to attract
and retain qualified personnel to design, test, market, and service our products
and manage our business. Competition for these technical and management
employees is significant. We cannot assure you that we will be successful in
attracting and retaining such personnel.
Our limited resources may prevent us from developing additional products or
services.
We have limited financial, management, research, and development resources.
Plans by us to develop additional products and services may require additional
management or capital that may not be available at the appropriate time or at a
reasonable cost. In addition, these products and services may divert our
resources from the development and marketing of the Mobetron system, which could
decrease our revenue and potential earnings.
The preparation of our financial statements requires us to make estimates and
assumptions and apply certain critical accounting policies that could materially
affect the reported amounts of our assets, liabilities, revenues and expenses.
Estimates and assumptions used in our financial statements are based on
historical experience and on various other factors that we believe are
reasonable under the circumstances, the results of which form the basis for
making judgments about the carrying values of assets and liabilities that are
not readily apparent from other sources. These estimates and assumptions also
require the application of certain accounting policies, many of which require
estimates and assumptions about future events and their effect on amounts
reported in the financial statements and related notes.
We periodically review our accounting policies and estimates and make
adjustments when facts and circumstances dictate. Actual results may differ from
these estimates under different assumptions or conditions. Any differences may
have a material impact on our financial condition and results of operations.
21
We believe that the following critical accounting policies also require us
to make assumptions and estimates that could materially affect the reported
amounts of our assets, liabilities, revenues and expenses. We use the specific
identification method to set reserves for both doubtful accounts receivable and
the valuation of our inventory, and use historical cost information to determine
our warranty reserves. Further, in assessing the fair value of certain option
and warrant grants, we have valued these instruments based on the Black-Scholes
model, which requires estimates of the volatility of our stock and the market
price of our shares, which, when there was no public market for shares, was
based on estimates of fair value made by our Board of Directors.
We are required to recognize expense for share-based compensation related to
stock and there can be no assurance that the expense that we are required to
recognize accurately measures the value of our share-based payment awards and
the recognition of this expense could cause the trading price of our common
stock to decline.
On January 1, 2006, we adopted Accounting Standards Codification ("ASC")
718-10 (previously Statement of Financial Accounting Standards No. 123 (revised
2004), Share-Based Payment, or SFAS 123(R)), using the modified prospective
transition method, which requires the measurement and recognition of
compensation expense for all share-based payment awards made to our employees
and directors, including stock options and restricted stock based on their fair
values. As a result, our operating results contain, and our operating results
for future periods will contain, a charge for share-based compensation related
to stock. This charge is in addition to other share-based compensation expense
we have recognized in prior periods.
The application of ASC 718-10 requires the use of an option-pricing model,
such as the Black-Scholes option-pricing model, to determine the fair value of
share-based payment awards. Option-pricing models were developed for use in
estimating the value of traded options that have no vesting restrictions and are
fully transferable. Our stock options have characteristics significantly
different from those of traded options, and changes in the assumptions (such as
expected term, stock price volatility and other variables) can materially affect
the fair value estimates. Therefore, although we determine the fair value of
stock options in accordance with ASC 718-10 and Staff Accounting Bulletin 107,
the existing valuation models may not provide an accurate measure of such fair
value, and there can be no assurance that the resulting expense that we are
required to recognize accurately measures that value.
As a result of the adoption of ASC 718-10, our earnings for the periods
subsequent to our adoption of ASC 718-10 were lower than they would have been
had we not adopted ASC 718-10. This will continue to be the case for future
periods. We cannot predict the effect that this decrease in earnings will have
on the trading price of our common stock.
RISKS RELATING TO OUR INDUSTRY
We are subject to intense competition, and our industry is subject to rapid,
unpredictable, and significant technological change.
The medical device industry is subject to rapid, unpredictable, and
significant technological change. Our business is also subject to competition
in the United States and abroad from a variety of sources, including
universities, research institutions, conventional medical linear accelerator
manufacturers, other medical device companies and pharmaceutical companies. Many
of these potential competitors have substantially greater technical, financial,
and regulatory resources than we do and are accordingly better equipped to
develop, manufacture, and market their products. If these companies develop and
introduce products and processes competitive with or superior to our products,
we may not be able to compete successfully against them.
22
Conventional medical linear accelerator manufacturers have sold a small
number of modified conventional accelerators and could continue to offer
essentially the same type of conventional unshielded system. Additionally, two
other manufacturers, NRT and Info & Tech, are known to us to have developed
systems that are light enough for operating room use.
NRT, an Italian company, is offering a modified, non-shielded IOERT unit
called the Novac 7. This linear accelerator system was developed, in part, with
funding from the Italian government. A spin-off of NRT, called Info & Tech
manufactured a system called the Liac in an attempt to replace the Novac 7 in
the market. Info & Tech delivered a small number of pre-commercial units to its
customers but has now filed for bankruptcy. Sordina, SpA has acquired the
assets of Info & Tech through Gia Marco and we believe Sordina will continue to
market and develop the product. The features and technology of the Liac system
are very similar to that of the NRT system. NRT and Sordina are both developing
higher energy versions of their systems so that they can be more competitive
with the features of the Mobetron. Both of these competitors have had some
sales success, mainly sales of Liac in Italy, where we view the Novac 7 and the
Liac as significant competition.
The possibility of significant competition from other companies with
substantial resources also exists. The cancer treatment market is subject to
intense research and development efforts all over the world, and we can face
competition from competing technologies that treat cancer in a different manner.
It is also likely that other competitors will emerge in the markets that we
intend to commercialize. We cannot assure you that our competitors will not
develop technologies or obtain regulatory approval for products that may be more
effective than the Mobetron or other products we may develop and that our
technologies and products would not be rendered less competitive or obsolete by
such developments.
We are subject to extensive government regulation.
The development, testing, manufacturing, and marketing of the Mobetron are
regulated by the U.S. Food and Drug Administration, or FDA, which requires
government clearance of such products before they are marketed. We filed and
received 510(k) pre-market notification clearance from the FDA in July 1998. We
received clearance for sales in Japan, or JIS, in May 2000, received European EC
Certificate approval, or CE Mark, on October 12, 2001 and received the approval
to market and sell in China, or SFDA, on November 23, 2003. However, we may
need to obtain additional approvals from the FDA or other governmental
authorities if we decide to change or modify the Mobetron. In that case, the FDA
or other authorities, at their discretion, could choose not to grant any new
approvals. In addition, if we fail to comply with FDA or other regulatory
standards, we could be forced to withdraw our products from the market or be
sanctioned or fined.
We are also subject to federal, state, and local regulations governing the
use, generation, manufacture, and testing of radiation equipment, including
periodic FDA inspections of manufacturing facilities to determine compliance
with FDA regulations. In addition, we must comply with federal, state, and
local regulations regarding the manufacture of healthcare products and
radiotherapy accelerators, including good manufacturing practices regulations,
suggested state regulations for the control of radiation, or SSRCR, and
International Electrotechnical Committee requirements, and similar foreign
regulations and state and local health, safety, and environmental regulations.
Although we believe that we have complied in all material respects with
applicable laws and regulations, we cannot assure you that we will not be
required to incur significant costs in the future in complying with
manufacturing and environmental regulations. Any problems with our or our
manufacturers' ability to meet regulatory standards could prevent us from
marketing the Mobetron or other products.
23
We expect to be highly dependent on overseas sales.
We believe that a substantial portion of our sales over at least the next
few years will be made to overseas customers. Our business, financial
condition, and results of operations could be materially adversely affected by
changes or uncertainties in the political or economic climates, laws,
regulations, tariffs, duties, import quotas, or other trade, intellectual
property or tax policies in the United States or foreign countries. We may also
be subject to adverse exchange rate fluctuations between local currencies and
the U.S. dollar should revenue be collectable or expenses paid in local
currencies.
Additionally, we have limited experience in many of the foreign markets in
which we plan to sell our goods and services. To succeed, we will have to
overcome cultural and language issues and expand our presence overseas. No
assurance can be given that we can meet these goals. We may be subject to
taxation in foreign jurisdictions, and transactions between any of our foreign
subsidiaries and us may be subject to U.S. and foreign withholding or other
taxes. We may also encounter difficulties due to longer customer payment cycles
and encounter greater difficulties in collecting accounts receivable from our
overseas customers. Further, should we discontinue any of our international
operations, we may incur material costs to cease those operations. An inability
to expand our overseas presence or manage the risks inherent in that expansion
could have a material adverse affect on our business, financial condition, and
results of operations.
IOERT treatment may not become a "standard of care" for cancer treatment.
IOERT is not yet considered to be a "standard of care" by the majority of
cancer practitioners. In fact, IOERT may never develop into a "standard of
care" for the treatment of cancer, in which case the market potential for the
Mobetron and other IOERT techniques will remain limited. If the market remains
limited, we may not be able to achieve sustained profitability or profitability
at all.
Our success in selling Mobetron systems in the United States may depend on
increasing reimbursement for IOERT services.
Hospitals in the United States pay increasing attention to treatment costs,
return on assets, and time to investment recovery when making capital purchase
decisions. The current U.S. reimbursement rates for treatment of advance
cancers and breast cancers using IOERT are relatively low, which potentially
makes the rate of return on capital invested in Mobetron less favorable compared
to the rate of return for external beam and other radiotherapy delivery systems.
While we are making efforts to increase the rate of reimbursement to improve the
rate of return on the capital investment in the Mobetron for hospitals in the
United States, there is no assurance that such an effort will be ultimately
successful. Although Medicare reimbursement is available for certain Mobetron
treatments, and although Medicare has recently established an additional billing
code that may allow increased reimbursement for patients who undergo Mobetron
treatment, the rate of reimbursement under the new code, if any, has not been
set, and it may take a number of years before Medicare has enough data to
establish the reimbursement rate under the new code, if any. Meanwhile,
reimbursement under the already established codes, as with all Medicare codes,
is subject to change or elimination. Therefore, regardless of positive clinical
outcomes, the current United States reimbursement environment may slow the
widespread acceptance of IOERT and the Mobetron in the U.S. market.
24
The current U.S. reimbursement for the Mobetron dermatology treatment is
competitive with existing treatments, such as x-ray and Mohs surgery. As with
all reimbursement codes, however, this code is subject to yearly review and
adjustment, and it could be decreased or eliminated in the future.
If our revenue stream were to become more dependent upon third-party payors such
as insurance companies, our revenues could decrease and our business could
suffer.
The system of health care reimbursement in the United States is being
intensively studied at the federal and state level. There is a significant
probability that federal and state legislation will be enacted that may have a
material impact on the present health care reimbursement system. If, because of
a change in the law or other unanticipated factors, certain third-party payors
(primarily insurance companies) were to become a more substantial source of
payment for our products in the future, our revenues may be adversely affected.
This is because such payors commonly negotiate cost structures with individual
hospitals that are below the prevailing market rate and typically negotiate
payment arrangements that are less advantageous than those available from other
private payors. Payment by third-party payors could also be subject to
substantial delays and other problems related to receipt of payment. The health
care industry, and particularly the operation of reimbursement procedures, has
been characterized by a great deal of uncertainty, and accordingly no assurance
can be given that third-party payors will not become a significant source of
payment for our products, or that such a change in payment policies will not
occur. Any of these factors could have a material adverse effect on our
business and financial condition. We cannot assure that such legislation will
not restrict hospitals' ability to purchase equipment such as the Mobetron or
that such legislation will not have a material adverse affect on our ability to
sell the Mobetron and on our business, financial condition, and results of
operation.
Our success in leasing the Mobetron DermaBeam system in the United States
may depend on maintaining the existing technical fee reimbursement for EBRT
services along with continued compliance with various state and federal
regulations focused on the placement of medical equipment in a dermatology
office.
Our strategy in the dermatology market depends on our ability to lease
Mobetron units to dermatologists, who would then use the Mobetron to deliver
EBRT services. The existing technical fee reimbursement for EBRT for skin cancer
is approximately $6,000 per treatment course based on average US global billings
for 25 fractions. Actual rates and billings for CMS and private payers will vary
by location and may decrease over time. If the technical reimbursement rate for
EBRT were to decrease, our ability to lease Mobetron units to dermatologists may
suffer and we may be forced to reduce our leasing rates, which could have a
material adverse effect on our business, financial condition and results of
operations.
In addition, various state and federal regulations focus on the contractual
relationship between the referring physician, the equipment owner and the
service provider. We have carefully constructed our turnkey leasing program to
be compliant with existing federal and state regulations. However, these
regulations are subject to change which could make our existing turnkey leasing
program non-compliant as it is currently structured. If so, we may be forced to
discontinue our leasing program and our business, financial condition and
results of operation may suffer.
25
RISKS RELATED TO OUR COMMON STOCK
The trading market for our common stock is limited.
Our common stock is quoted on the OTC Bulletin Board under the symbol
"IOPD.OB." The trading market for our common stock is limited. Accordingly, we
cannot assure you the liquidity of any markets that may develop for our common
stock, the ability of holders of our common stock to sell our common stock, or
the prices at which holders may be able to sell our common stock.
Our stock price may be volatile.
The market price of our common stock is likely to be highly volatile and
could fluctuate widely in price in response to various factors, many of which
are beyond our control, including:
-- technological innovations;
-- introductions or withdrawals of new products and services by us
or our competitors;
-- additions or departures of key personnel;
-- large sales of our common stock;
-- our ability to integrate operations, technology, products and
services;
-- our ability to execute our business plan;
-- operating results below expectations;
-- loss of any strategic relationship;
-- industry developments;
-- changes in the regulatory environment;
-- our recently completed one-for-fifty reverse stock split;
-- economic and other external factors; and
-- period-to-period fluctuations in our financial results.
In addition, the securities markets have from time to time experienced
significant price and volume fluctuations that are unrelated to the operating
performance of particular companies. These market fluctuations may also
materially and adversely affect the market price of our common stock.
We have not paid dividends in the past and do not expect to pay dividends in the
future. Any return on investment may be limited to the value of our common
stock.
We have never paid cash dividends on our common stock and do not anticipate
paying cash dividends in the foreseeable future. The payment of dividends on
our common stock will depend on earnings, financial condition and other business
and economic factors affecting the value of our common stock at such time as the
Board of Directors may consider relevant. If we do not pay dividends, our
common stock may be less valuable because a return on a stockholder's investment
will only occur if our stock price appreciates.
26
Our common stock may be deemed penny stock with a limited trading market.
Our common stock is currently listed for trading on the OTC Bulletin Board,
which is generally considered to be a less efficient market than markets such as
NASDAQ or other national exchanges, and which may cause difficulty in conducting
trades and difficulty in obtaining future financing. Further, our securities
are subject to the "penny stock rules" adopted pursuant to Section 15(g) of the
Securities Exchange Act of 1934, as amended, or the Exchange Act. The penny
stock rules apply to non-NASDAQ companies whose common stock trades at less than
$5.00 per share or which have tangible net worth of less than $5,000,000
($2,000,000 if the company has been operating for three or more years). Such
rules require, among other things, that brokers who trade "penny stock" to
persons other than "established customers" complete certain documentation, make
suitability inquiries of investors and provide investors with certain
information concerning trading in the security, including a risk disclosure
document and quote information under certain circumstances. Many brokers have
decided not to trade "penny stock" because of the requirements of the penny
stock rules and, as a result, the number of broker-dealers willing to act as
market makers in such securities is limited. If we remain subject to the "penny
stock rules" for any significant period, the market, if any, for our common
stock may suffer. Because our common stock is subject to the "penny stock
rules," investors will find it more difficult to dispose of our shares.
Further, for companies whose securities are traded on the OTC Bulletin Board, it
is more difficult to: (i) obtain accurate quotations; (ii) obtain coverage for
significant news events because major wire services, such as the Dow Jones News
Service, generally do not publish press releases about such companies; and (iii)
obtain needed capital.
Our stock may lose access to a viable trading market.
Given the increasing cost and resource demands of being a public company,
we may decide to "go dark," or cease filing with the Securities and Exchange
Commission, or the SEC, by deregistering its securities, for a period of time
until its assets and stockholder base are sufficient to warrant public trading
again. During such time, there would be a substantial decrease in disclosure by
us of our operations and prospects, and a substantial decrease in the liquidity
in our common stock even though stockholders may still continue to trade our
common stock in the OTC market or "pink sheets." The market's interpretation of
a company's motivation for "going dark" varies from cost savings, to negative
changes in the firm's prospects, to serving insider interests, which may effect
the overall price and liquidity of a company's securities.
A sale of a substantial number of shares of our common stock may cause the price
of our common stock to decline.
If our stockholders sell substantial amounts of our common stock in the
public market, including shares issued upon the exercise of outstanding options
or warrants, the market price of our common stock could fall. These sales also
may make it more difficult for us to sell equity or equity-related securities in
the future at a time and price that we deem reasonable or appropriate.
From August 2007 through the date of this filing, we issued, after
adjusting for warrant exercises in that same period, 7,326,208 shares of common
stock and warrants to purchase 242,814 shares of common stock, which in each
case have not been registered with the SEC and may not be sold except pursuant
to a registration statement filed with the SEC or an exemption from
registration, such as SEC Rule 144. Pursuant to certain agreements entered into
in August 2007, we have agreed to register 5,930,170 shares of common stock and
warrants to purchase 215,614 shares of common stock upon the demand of the
majority of the holders of those shares and warrants. The holders have not yet
demanded registration of their shares.
27
Ownership of our common stock is highly concentrated, and it may prevent you and
other stockholders from influencing significant corporate decisions and may
result in conflicts of interest that could cause our stock price to decline.
Our executive officers, directors and their affiliates beneficially owned
approximately 61% of our outstanding common stock as of December 31, 2009.
Accordingly, these executive officers, directors and their affiliates, acting
individually or as a group, can control the outcome of a corporate action of
ours requiring stockholder approval, including the election of directors, any
merger, consolidation or sale of all or substantially all of our assets or any
other significant corporate transaction. These stockholders may also delay or
prevent a change in control of us, even if such change in control would benefit
our other stockholders. The significant concentration of stock ownership may
adversely affect the value of our common stock due to investors' perception that
conflicts of interest may exist or arise.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
We are a party to a debenture purchase agreement (as amended, the "Purchase
Agreement") with E.U. Capital Venture, Inc., Encyclopedia Equipment LLC, Lacuna
Venture Fund LLLP, Lacuna Hedge Fund LLLP, VMG Holdings II, LLC, Rawleigh Ralls
and Hans Morkner, pursuant to which we have issued 10% senior secured debentures
("Debentures") and warrants to purchase shares of our common stock ("Warrants").
During the three months ended December 31, 2009, we issued and sold the
following Debentures and Warrants to Lacuna Venture Fund LLLP on the dates and
in the amounts indicated in accordance with the terms of the Purchase Agreement.
-----------------------------------------------------------------------------
Date Principal Amount of Debentures ($) Number of Warrants(#)
-----------------------------------------------------------------------------
November 20, 2009 $250,000 44,642
-----------------------------------------------------------------------------
December 9, 2009 150,000 26,785
-----------------------------------------------------------------------------
All outstanding principal and any accrued but unpaid interest on the
Debentures is payable in full on the earlier of (i) July 31, 2010 or (ii) the
date we close an issuance, or series of issuances, of promissory notes
convertible into shares of our common stock with gross aggregate proceeds
received by us of not less than $8,500,000 (other than pursuant to the Purchase
Agreement). In the event that (i) we close an issuance, or series of
issuances, of shares of our preferred stock (the "New Securities") with gross
aggregate proceeds received by us of not less than $1,000,000 and (ii) the
Debentures have not been paid in full, then the entire outstanding principal
balance and all accrued but unpaid interest thereon shall convert at the option
of the holder into shares of the New Securities at a conversion price equal to
the price per share paid by the investors purchasing the New Securities on the
same terms and conditions as given to such investors. The Warrants have a
five-year term, subject to early termination upon the occurrence of
certain events, and an exercise price of $1.40 per share.
We believe that each of the holders of the Debentures and the Warrants
described above are "accredited investors," and the issuance of such securities
is therefore being made pursuant to Regulation D promulgated under the
Securities Act of 1933, as amended.
28
Item 3. Defaults upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
None.
Item 5. Other Information
None.
Item 6. Exhibits
Exhibit
Number Description
------- -----------
10.57 Third Amendment to Loan Documents.
31.1 Certification of Chief Executive Officer pursuant to Rule 13a-14a.
31.2 Certification of Chief Financial Officer pursuant to Rule 13a-14a.
32.1 Section 1350 Certification of Chief Executive Officer.
32.2 Section 1350 Certification of Chief Financial Officer.
29
SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
INTRAOP MEDICAL CORPORATION
Date: February 12, 2010 By: /s/ John P. Powers
-------------------------------------------------
John P. Powers, Chief Executive Officer
and President
(Principal Executive Officer)
Date: February 12, 2010
By: /s/ JK Hullett
-------------------------------------------------
JK Hullett, Chief Financial Officer
(Principal Financial Officer and Principal
Accounting Officer)
30
IntraOp Medical Corporation
Index to Consolidated Financial Statements (Unaudited)
For the Three Months Ended December 31, 2009
Consolidated Balance Sheets Q-2
Consolidated Statements of Operations Q-3
Consolidated Statements of Cash Flows Q-4
Notes to Consolidated Financial Statements Q-6
Q-1
IntraOp Medical Corporation
Consolidated Balance Sheets - Unaudited
------------------------------------------------------------------------------------------------------------
December 31, September 30,
2009 2009 (1)
------------- -------------
ASSETS
Current assets:
Cash and cash equivalents $ 80,572 $ 673,351
Accounts receivable 2,593,754 4,381,542
Inventories, net 1,003,920 699,363
Inventories, under product financing arrangement 1,026,431 1,005,545
Prepaid expenses and other current assets 20,960 21,321
------------- -------------
Total current assets 4,725,637 6,781,122
Property and equipment, net 109,934 125,695
Leased equipment, net 761,107 782,055
Intangible assets, net 182,282 188,460
Deposits 66,818 65,794
------------- -------------
Total Assets $ 5,845,778 $ 7,943,126
============= =============
LIABILITIES AND STOCKHOLDERS' DEFICIT
Current liabilities:
Accounts payable $ 1,868,874 $ 2,079,814
Accrued liabilities 1,533,953 1,138,854
Capital lease obligations, current portion 2,326 2,519
Notes payable, related parties, current portion 119,002 119,002
Notes payable, other, current portion, net of unamortized debt discounts 9,458,011 9,815,458
------------- -------------
Total current liabilities 12,982,166 13,155,647
Capital lease obligations, net of current portion - 427
------------- -------------
Total liabilities 12,982,166 13,156,074
------------- -------------
Stockholders' deficit:
Common stock, $0.001 par value: 500,000,000 shares authorized;
7,855,894 shares issued and outstanding 392,795 392,795
Additional paid-in capital 42,259,180 42,057,760
Treasury stock, at cost, 12,000 shares at $12.50 per share (150,000) (150,000)
Accumulated deficit (49,638,363) (47,513,503)
------------- -------------
Total stockholders' deficit (7,136,388) (5,212,948)
------------- -------------
Total liabilities and stockholders' deficit $ 5,845,778 $ 7,943,126
============= =============
(1) The consolidated balance sheet as of September 30, 2009 was derived from audited financial
statements as of that date.
See accompanying notes to these financial statements.
Q-2
IntraOp Medical Corporation
Consolidated Statements of Operations - Unaudited
--------------------------------------------------------------------------------
Three months ended
December 31,
-------------------------
2009 2008
------------ ------------
Revenues:
Product sales $ 4,637 $ 1,093,619
Leasing 45,000 -
Service 111,429 104,647
------------ ------------
Total revenues 161,066 1,198,266
------------ ------------
Cost of revenues:
Product sales 49,407 994,261
Leasing 55,448 -
Service 44,427 49,565
------------ ------------
Total cost of revenues 149,282 1,043,826
------------ ------------
Gross margin 11,784 154,440
------------ ------------
Operating expenses:
Research and development 385,528 410,047
General and administrative 549,081 573,222
Sales and marketing 470,647 758,154
------------ ------------
Total operating expenses 1,405,256 1,741,423
------------ ------------
Loss from operations (1,393,472) (1,586,983)
Other income (853) 56,207
Interest income - 3
Interest expense (730,535) (286,249)
------------ ------------
Loss before taxes (2,124,860) (1,817,022)
Provision for income taxes - -
------------ ------------
Net loss $(2,124,860) $(1,817,022)
============ ============
Basic and diluted net loss per share
available to common shareholders $ (0.27) $ (0.23)
============ ============
Weighted average number of shares in
calculating net loss per share:
Basic and diluted 7,855,894 7,855,894
============ ============
See accompanying notes to these financial statements.
Q-3
IntraOp Medical Corporation
Consolidated Statements of Cash Flows - Unaudited
----------------------------------------------------------------------------------------------------------
Three months ended December 31,
-----------------------------------------
2009 2008
------------------- -------------------
Cash flows from operating activities:
Net loss $ (2,124,860) $ (1,817,022)
Adjustments to reconcile net loss to net cash
used for operating activities:
Depreciation of property and equipment 39,612 22,461
Amortization of intangible assets 20,478 19,573
Amortization of debt discount 298,864 13,020
Non-cash compensation for options issued 146,176 324,640
Non-cash compensation for warrants issued 55,244 -
Changes in assets and liabilities:
Accounts receivable 1,787,788 (1,027,462)
Inventories (325,443) 459,725
Prepaid expenses and other current assets 361 (5,620)
Other assets (1,024) 30,332
Accounts payable (210,939) 164,732
Accrued liabilities 395,098 (59,789)
------------------- -------------------
Net cash used for operating activities 81,355 (1,875,410)
------------------- -------------------
Cash flows used for investing activities:
Acquisition of fixed assets (2,903) (13,081)
Acquisition of intangible assets (14,300) -
------------------- -------------------
Net cash used for investing activities (17,203) (13,081)
------------------- -------------------
Cash flows provided by financing activities:
Proceeds from note payable, other 700,000 4,507,579
Payments on note payable, other (1,356,931) (2,868,120)
------------------- -------------------
Net cash provided by financing activities (656,931) 1,639,459
------------------- -------------------
Net decrease in cash and cash equivalents (592,779) (249,032)
Cash and cash equivalents, at beginning of period 673,351 282,516
------------------- -------------------
Cash and cash equivalents, at end of period $ 80,572 $ 33,484
=================== ===================
See accompanying notes to these financial statements.
Q-4
IntraOp Medical Corporation
Consolidated Statements of Cash Flows - Unaudited (Continued)
----------------------------------------------------------------------------------
Three months ended December 31,
--------------------------------
2009 2008
-------------- ---------------
Supplemental disclosure of cash flow information:
Cash paid for interest $ 143,102 $ 233,914
Income taxes paid - -
See accompanying notes to these financial statements.
(Remainder of page intentionally left blank)
Q-5
INTRAOP MEDICAL CORPORATION NOTES TO THE
CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1 - INTRAOP MEDICAL CORPORATION AND SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES
Basis of Presentation:
The consolidated financial statements have been prepared by the Company pursuant
to the rules and regulations of the Securities and Exchange Commission ("SEC").
Certain information and note disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been or omitted pursuant to such rules and regulations. These consolidated
financial statements and the accompanying notes are unaudited and should be read
in conjunction with the consolidated financial statements and the notes thereto
included in the Company's Annual Report on Form 10-K for the year ended
September 30, 2009. In the opinion of management, the consolidated financial
statements herein include adjustments (consisting only of normal recurring
adjustments) necessary for a fair presentation of the Company's financial
position as of December 31, 2009, and the results of operations for the three
months ended December 31, 2009 and December 31, 2008. The results of operations
for the three months ended December 31, 2009 are not necessarily indicative of
the operating results to be expected for the full fiscal year or any future
periods.
Formation and Business of the Company:
Intraop Medical Corporation (the "Company") was incorporated in Nevada on
November 5, 1999. The Company's business is the development, manufacture,
marketing, distribution and service of the Mobetron, a proprietary mobile
electron-beam cancer treatment system designed for use in intraoperative
electron-beam radiation therapy, or IOERT as well as external beam radiation
therapy or EBRT. The IOERT procedure involves the direct application of
radiation to a tumor and/or tumor bed while a patient is undergoing surgery for
cancer. EBRT is the external application of radiation to the tumor site while
the patient is undergoing treatment for skin cancer.
Basis of Consolidation:
For the three months ended December 31, 2009 and December 31, 2008, the
consolidated financial statements include the accounts of IntraOp Medical
Corporation, IntraOp Medical Services, Inc. and IntraOp Medical Europe Ltd. All
significant inter-company balances and transactions have been eliminated in
preparation of the consolidated financial statements.
Q-6
NOTE 1 - INTRAOP MEDICAL CORPORATION AND SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES (CONTINUED)
Going Concern:
The accompanying consolidated financial statements have been prepared in
conformity with generally accepted accounting principles in the United States,
which contemplate continuation of the Company as a going concern. However, the
Company has experienced net losses of $2,124,860 and $1,817,022 for the three
months ended December 31, 2009 and 2008, respectively. In addition, the Company
has incurred substantial monetary liabilities in excess of monetary assets over
the past several years and, as of December 31, 2009, had an accumulated deficit
of $49,638,363. These matters, among others, raise substantial doubt about the
Company's ability to continue as a going concern. In view of the matters
described above, recoverability of a major portion of the recorded asset amounts
shown in the accompanying consolidated balance sheet is dependent upon the
Company's ability to generate sufficient sales volume to cover its operating
expenses and to raise sufficient capital to meet its payment obligations.
Management is taking action to address these matters, which include:
- Retaining experienced management personnel with particular skills in the
development and sale of its products and services.
- Developing new markets overseas and expanding its sales efforts within the
United States.
- Evaluating funding strategies in the public and private markets.
Historically, management has been able to raise additional capital. During the
three months ended December 31, 2009, the Company obtained capital through the
issuance of notes of approximately $400,000. The consolidated financial
statements do not include any adjustments relating to the recoverability and
classification of recorded asset amounts, or amounts and classification of
liabilities that might be necessary should the Company be unable to continue in
existence. The successful outcome of future activities cannot be determined at
this time and there is no assurance that if achieved, the Company will have
sufficient funds to execute its intended business plan or generate positive
operating results
Concentration of Credit Risk:
The Company maintains its cash in bank accounts, which at times may exceed
federally insured limits. The Company has not experienced any losses on such
accounts. Credit risk with respect to accounts receivable is concentrated due
to the limited number of transactions recorded in any particular period. See
Note 2 for further discussion of these concentrations.
Use of Estimates:
The preparation of consolidated financial statements, in conformity with
accounting principles generally accepted in the United States of America,
requires management to make estimates and assumptions that affect the amounts in
the financial statements and accompanying notes. Actual results could differ
from those estimates.
Management makes estimates that affect reserves for allowance for doubtful
accounts, deferred income tax assets, estimated useful lives of property and
equipment, and accrued expenses, fair value of equity instruments and reserves
for any other commitments or contingencies. Any adjustments applied to
estimates are recognized in the period in which such adjustments are determined.
Q-7
NOTE 1 - INTRAOP MEDICAL CORPORATION AND SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES (CONTINUED)
Revenue Recognition:
Revenue is recognized when earned in accordance with applicable accounting
standards, including Accounting Standards Codification ('ASC") 605-10
(previously Staff Accounting Bulletins 104, Revenue Recognition in Financial
Statements ("SAB 104")), and the interpretive guidance issued by the Securities
and Exchange Commission and ASC 605-25 (previously EITF issue number 00-21,
Accounting for Revenue Arrangements with Multiple Elements, of the FASB's
Emerging Issues Task Force). The Company recognizes revenue on sales of
machines upon delivery, provided there are no uncertainties regarding
installation or acceptance, persuasive evidence of a binding sales agreement
exists, the sales price is fixed or determinable, and collection of the related
receivable is reasonably assured. Revenue from maintenance is recognized as
maintenance services are completed or over the term of the maintenance
agreements. Revenue from the leasing of machines is recognized over the term of
the lease agreements.
The Company recognized revenue on service contracts for the service of Mobetron
at the customer site with seven customers during the three months ended December
31, 2009 and six customers during the three months ended December 31, 2008.
Under these agreements, customers agree to a one-year service contract for which
they receive warranty-level labor and either full coverage or a credit for a
certain contracted dollar amount for service-related parts. On contracts with
credit for service-related parts, the Company recorded a liability for parts
equal to the amount of the parts credit contracted for by the customer with the
remainder of the contract price recorded as labor related service contract
liability. On full coverage contract, the Company recorded the contract price
as service contract liability.
Intangible Assets:
Intangible assets consist primarily of capitalized costs relating to a Japanese
device approval license for sale of Mobetron and amounts paid for certain
non-recurring engineering expenses paid to third parties for the development of
certain Mobetron subsystems. Non-recurring engineering expenses related to the
Mobetron are amortized on a straight-line basis over their estimated useful
lives of five years. The medical device approval license has an indefinite life
and therefore is not subject to amortization.
The Company evaluates the carrying value of its intangible assets during the
fourth fiscal quarter of each year and between annual evaluations if events
occur or circumstances change that would more likely than not reduce the fair
value of the asset below its carrying amount. Such circumstances could include,
but are not limited to: (1) a significant adverse change in legal factors or in
business climate, (2) unanticipated competition, or (3) an adverse action or
assessment by a regulator.
The Company's evaluation of its intangible assets completed during three months
ended September 30, 2009 resulted in no impairment losses.
Q-8
NOTE 1 - INTRAOP MEDICAL CORPORATION AND SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES (CONTINUED)
Income Taxes:
The Company accounts for its income taxes using the Financial Accounting
Standards Board Statements of ASC No. 740-10, "Accounting for Income Taxes,"
which requires the establishment of a deferred tax asset or liability for the
recognition of future deductible or taxable amounts and operating loss and tax
credit carry forwards. Deferred tax expense or benefit is recognized as a
result of timing differences between the recognition of assets and liabilities
for book and tax purposes during the year.
Deferred tax assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled. Deferred tax assets are
recognized for deductible temporary differences and operating loss, and tax
credit carry forwards. A valuation allowance is established to reduce that
deferred tax asset if it is "more likely than not" that the related tax benefits
will not be realized. The Company has recorded a full valuation allowance
against its deferred tax assets.
Basic and Diluted Loss per Share:
In accordance with ASC No. 260-10, Earnings per Share, basic loss per share is
computed by dividing the loss attributable to common stockholders by the
weighted average number of common shares outstanding during the period. Basic
net loss per share excludes the dilutive effect of stock options or warrants and
convertible notes. Further, basic and diluted net loss per share was the same
for all periods presented because the inclusion of potential dilutive shares in
the calculation of net loss per share on a fully diluted basis would have
resulted in a lower net loss per share, creating in anti-dilutive effect.
The following table sets forth the computation of basic and diluted net loss per
common share:
Three months ended
December 31,
-------------------------
2009 2008
------------ ------------
Numerator
Net loss available to common stockholders $(2,124,860) $(1,817,022)
Denominator
Weighted average common shares outstanding 7,855,894 7,855,894
------------ ------------
Total shares, basic 7,855,894 7,855,894
============ ============
Net loss per common shares
Basic and diluted $ (0.27) $ (0.23)
============ ============
Q-9
NOTE 1 - INTRAOP MEDICAL CORPORATION AND SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES (CONTINUED)
The potential dilutive shares, which are excluded from the determination of
basic and diluted net loss per share as their effect is anti-dilutive, are as
follows:
Three months ended
December 31,
-------------------------------
2009 2008
--------------- -------------
Options to purchase common stock 591,221 606,841
Warrants to purchase common stock 1,143,878 324,459
--------------- -------------
Potential equivalent shares excluded 1,735,099 931,300
=============== =============
Comprehensive Loss:
Comprehensive loss consists of net loss and other gains and losses affecting
stockholders' equity that, under generally accepted accounting principles are
excluded from net loss in accordance with Statement of ASC No. 220-10, Reporting
Comprehensive Income. The Company, however, does not have any components of
other comprehensive loss as defined by ASC No. 220-10 and therefore, for the
three months ended December 31, 2009 and 2008, comprehensive loss is equivalent
to the Company's reported net loss. Accordingly, a statement of comprehensive
loss is not presented.
Segment:
The Company operates in a single business segment that includes the design,
development, and manufacture of the Mobetron. The Company does however disclose
geographic area data based on product shipment destination. The geographic
summary of long-lived assets is based on physical location.
Recent Accounting Pronouncements:
In June 2008, the FASB issued ASC 260-10 (previously FASB Staff Position ("FSP")
on EITF No. 03-6-1), Determining Whether Instruments Granted in Share-Based
Payment Transactions Are Participating Securities. Under the ASC, unvested
share-based payment awards that contain rights to receive non-forfeitable
dividends (whether paid or unpaid) are participating securities, and should be
included in the two-class method of computing earnings per share. The ASC 260-10
is effective for years beginning after December 15, 2008, and interim periods
within those years. With effect from the fiscal year beginning October 1, 2009
the Company implemented the ASC 260-10 and has no significant impact on the
Company's results of operations, financial condition or liquidity.
In April 2008, the FASB issued ASC 350-10 (previously FSP FAS No. 142-3), which
amends the factors that must be considered in developing renewal or extension
assumptions used to determine the useful life over which to amortize the cost of
a recognized intangible asset under ASC 350-10 (previously FAS No. 142),
Goodwill and Other Intangible Assets. The ASC requires an entity to consider its
own assumptions about renewal or extension of the term of the arrangement,
consistent with its expected use of the asset, and is an attempt to improve
consistency between the useful life of a recognized intangible asset under ASC
350-10 and the period of expected cash flows used to measure the fair value of
the asset under ASC 805-10 (previously FAS No. 141), Business Combinations. The
ASC is effective for years beginning after December 15, 2008, and the guidance
for determining the useful life of a recognized intangible asset must be applied
prospectively to intangible assets acquired after the effective date. With
effect from the fiscal year beginning October 1, 2009 the Company adopted the
ASC 350-10 and has no impact on the Company's results of operations, financial
condition or liquidity.
Q-10
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
In December 2007, the FASB revised ASC 805-10 (previously FAS No. 141(R)),
Applying the Acquisition Method. ASC 805-10 provides guidance for the
recognition of the fair values of the assets acquired upon initially obtaining
control, including the elimination of the step acquisition model. The
codification is effective for acquisitions made in years beginning after
December 15, 2008. The Company adopted ASC 805-10 with effect from October 1,
2009, and is not expected to have a significant impact on the Company's results
of operations, financial condition or liquidity.
In June 2008, the FASB ratified the consensus reached on ASC 815-40 (previously
EITF Issue No. 07-05), Determining Whether an Instrument (or an Embedded
Feature) is Indexed to an Entity's Own Stock . ASC 815-40 provides guidance for
determining whether an equity-linked financial instrument (or embedded feature)
is indexed to an entity's own stock. ASC 815-40 applies to any freestanding
financial instrument or embedded feature that has all the characteristics of a
derivative under ASC 815-10-15 (previously paragraphs 6-9 of SFAS 133), for
purposes of determining whether that instrument or embedded feature qualifies
for the first part of the scope exception under paragraph 11(a) of ASC 815-10
(previously SFAS 133) and for purposes of determining whether that instrument is
within the scope of ASC 815-40 (previously EITF No. 00-19) Accounting for
Derivative Financial Instruments Indexed to, and Potentially Settled in, a
Company's Own Stock, which provides accounting guidance for instruments that are
indexed to, and potentially settled in, the issuer's own stock. ASC 815-40 is
effective for years beginning after December 15, 2008, and early adoption is not
permitted. The Company is currently evaluating the impact of this pronouncement
on its consolidated financial statements.
In June 2009, the FASB issued ASC 860-10 (previously Statement No. 166),
Accounting for Transfers of Financial Assets - an amendment of FASB Statement
No. 140. ASC 860-10 eliminates the exceptions for qualifying special-purpose
entities from consolidation guidance and the exception that permitted sale
accounting for certain mortgage securitizations when a transferor has not
surrendered control over the transferred financial assets. ASC 860-10 is
effective as of the beginning of the first annual reporting period that begins
after November 15, 2009. The Company adopted the ASC 860-10 with effect from
October 1, 2009 and currently has no impact on the adoption of ASC 860-10 on the
financial statements.
In June 2009, the FASB issued ASC 810-10 (previously Statement No. 167),
Amendments to FASB Interpretation No. 46(R). ASC 810-10 amends Interpretation of
46(R) to require an enterprise to perform an analysis to determine whether the
enterprise's variable interest or interests give it a controlling financial
interest in a variable interest entity. ASC 810-10 is effective as of the
beginning of the first annual reporting period that begins after November 15,
2009. Earlier application is prohibited. The Company is currently evaluating the
impact the adoption of ASC 810-10 will have on the financial statements.
Q-11
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Accounting Standards Codification
In June 2009, the FASB issued its Accounting Standards Codification ("ASC"),
codifying all previous sources of accounting principles into a single source of
authoritative, nongovernmental U.S. generally accepted accounting principles
("U.S. GAAP"). Although the ASC supersedes all previous levels of authoritative
accounting standards, it did not affect accounting principles under U.S. GAAP.
The Company adopted the codification effective September 30, 2009.
In August 2009, the FASB issued ASC 2009 - 05, Fair Value Measurements and
Disclosures (Topic 820) - Measuring Liabilities at Fair Value to provide
guidance when estimating the fair value of a liability. When a quoted price in
an active market for the identical liability is not available, fair value should
be measured using:
- The quoted price of an identical liability when traded as an asset,
- Quoted prices for similar liabilities or similar liabilities when
trades as assets, or
- Another valuation technique consistent with the principles of
Topic 820 such as an income approach or a market approach
If a restriction exists that prevents the transfer of the liability, a separate
adjustment related to the restriction is not required when estimating fair
value. Its adoption is not expected to have a material impact on our financial
position, results of operations, or cash flows.
In September 2009, the FASB issued Accounting Standards Update (ASU) 2009-12,
Fair Value Measurements and Disclosures (Topic 820) - Investments in Certain
Entities That Calculate Net Asset Value per Share (or Its Equivalent). This ASU
allows a company to measure the fair value of an investment that has no readily
determinable fair value on the basis of the investee's net asset value per share
as provided by the investee. This allowance assumes that the investee has
calculated net asset value in accordance with the GAAP measurement principles of
Topic 946 as of the reporting entity's measurement date. Examples of such
investments include investments in hedge funds, private equity funds, real
estate funds and venture capital funds. The update also provides guidance on how
the investment should be classified within the fair value hierarchy based on the
value for which the investment can be redeemed. The amendment is effective for
interim and annual periods ending after December 15, 2009 with early adoption
permitted.
Q-12
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
In October 2009, the FASB issued two new accounting standards updates that:
- Revise accounting and reporting requirements for arrangements
with multiple deliverables. This update allows the use of an estimated
selling price to determine the selling price of a deliverable in cases
where neither vendor-specific objective evidence nor third-party
evidence is available, which is expected to increase the ability for
entities to separate deliverables in multiple-deliverable arrangements
and, accordingly, to decrease the amount of revenue deferred in these
cases. Additionally, this update requires the total selling price of a
multiple-deliverable arrangement to be allocated at the inception of
the arrangement to all deliverables based on relative selling prices.
- Clarify which revenue allocation and measurement guidance should
be used for arrangements that contain both tangible products and
software, in cases where the software is more than incidental to the
tangible product as a whole. More specifically, if the software sold
with or embedded within the tangible product is essential to the
functionality of the tangible product, then this software, as well as
undelivered related software elements is excluded from the scope of
existing software revenue guidance, which is expected to decrease the
amount of revenue deferred in these cases
These updates are to be applied prospectively for revenue arrangements entered
into or materially modified in fiscal years beginning on or after June 15, 2010,
which for the Company is its fiscal 2011, and must be adopted at the same time.
Early adoption is permitted, and if these updates are adopted early in other
than the first quarter of our fiscal year, then they must be applied
retrospectively to the beginning of that fiscal year. The Company is currently
evaluating the impact the adoption of these updates will have on its financial
position, results of operations and cash flows.
In October 2009, the FASB issued ASU 2009-13 ("FASB ASU 09-13"), Revenue
Recognition (Topic 605): Multiple-Deliverable Revenue Arrangements (a consensus
of the FASB Emerging Issues Task Force). FASB ASU 09-13 updates the existing
multiple-element arrangement guidance currently in FASB Topic 605-25 (Revenue
Recognition - Multiple-Element Arrangements). This new guidance eliminates the
requirement that all undelivered elements have objective evidence of fair value
before a company can recognize the portion of the overall arrangement fee that
is attributable to the items that have already been delivered. Further,
companies will be required to allocate revenue in arrangements involving
multiple deliverables based on the estimated selling price of each deliverable,
even though such deliverables are not sold separately by either company itself
or other vendors. This new guidance also significantly expands the disclosures
required for multiple-element revenue arrangements. The revised guidance will be
effective for the first annual period beginning on or after June 15, 2010. The
Company may elect to adopt the provisions prospectively to new or materially
modified arrangements beginning on the effective date or retrospectively for all
periods presented. The Company is currently evaluating the impact FASB ASU 09-13
will have on its consolidated financial statements.
Q-13
NOTE 2 - MAJOR CUSTOMERS AND VENDORS
Three customers represent 43.2%, 25.5% and 19.9% of accounts receivable at
December 31, 2009. Three customers accounted for 27.9%, 1.3% and 1.3% of net
revenue for the three months ended December 31, 2009. Three customers accounted
for 81.5%, 8.7%, and 5.8% of net revenue for the three months ended December 31,
2008.
Three suppliers represented 19.85%, 7.32% and 6.88% of accounts payable at
December 31, 2009. Purchases from these suppliers during the three months ended
December 31, 2009 totaled approximately $0, $0 and $45,304. Purchases from these
suppliers during the three months ended December 31, 2008 totaled approximately
$0, $0 and $53,230 respectively.
NOTE 3 - BALANCE SHEET COMPONENTS
Inventory:
Inventory consists of the following:
December 31, September 30,
2009 2009
------------ -------------
Finished goods $ - $ -
Work-in-progress 114,034 52,795
Purchased parts and raw material, net of reserves of
$211,932 (at September 30, 2009 $211,932) 889,886 646,568
------------ -------------
$ 1,003,920 $ 699,363
============ =============
Inventories, under product financing arrangement:
Inventories under product financing arrangements consist of the following:
December 31, September 30,
2009 2009
------------ -------------
Finished goods $ - $ -
Work-in-progress 1,026,431 1,005,545
Purchased parts and raw material - -
------------ -------------
$ 1,026,431 $ 1,005,545
============ =============
Under the Company's Product Financing Arrangement and Inventory Financing
Arrangement (see Note 4), ownership of the financed inventory is transferred to
the lender. However, the Company has the right to subsequently repurchase
financed inventory from the lender at a price equal to the original transfer
price plus interest.
Q-14
NOTE 3 - BALANCE SHEET COMPONENTS (CONTINUED)
Property and Equipment and Leased Equipment:
Property and Equipment and Leased Equipment consist of the following:
December 31, September 30,
2009 2009
-------------- ---------------
Property & equipment $ 284,317 $ 284,317
Computer equipment 129,684 126,781
Furniture & fixtures 72,311 72,311
Leasehold improvements 37,420 37,420
-------------- ---------------
523,732 520,829
Less: accumulated depreciation (413,798) (395,134)
-------------- ---------------
$ 109,934 $ 125,695
============== ===============
Included in property and equipment is an asset acquired under a capital lease
with an original cost of $11,742 as of December 31, 2009 and as of December 31,
2008. Related accumulated depreciation and amortization of this asset was
$10,176 and $7,828 as of December 31, 2009 and December 31, 2008 respectively.
Leased Equipment:
Leased Equipment consists of the following:
December 30, September 30,
2009 2009
------------- ---------------
Mobetron leased to a customer $ 837,916 $ 837,916
Less: accumulated depreciation (76,809) (55,861)
------------- ---------------
$ 761,107 $ 782,055
============= ===============
Intangible Assets:
Intangible Assets consist of the following:
December 31, September 30,
2009 2009
-------------- ---------------
Non-recurring engineering charges paid to
third parties $ 417,600 $ 403,300
Less accumulated amortization (265,318) (244,840)
-------------- ---------------
Mobetron related manufacturing and design
rights, net 152,282 158,460
Medical device approval license not subject
to amortization 30,000 30,000
-------------- ---------------
Intangible assets, net $ 182,282 $ 188,460
============== ===============
The Company's historical and projected revenues are related to the sale and
servicing of the Company's sole product, the Mobetron. Should revenues of the
Mobetron product in future periods be significantly less than management's
expectation, the benefit from the Company's Mobetron related intangibles would
be limited and may result in an impairment of these assets.
Q-15
NOTE 3 - BALANCE SHEET COMPONENTS (CONTINUED)
Accrued Liabilities:
A summary is as follows:
December 31, September 30,
2009 2009
------------- ---------------
Contract advances $ 15,000 $ 15,000
Accrued interest payable 783,411 550,511
Accrued warranty 112,998 167,428
Deferred revenue 359,236 161,352
Accrued wages and benefits payable 214,484 195,549
Accrued sales tax payable 8,824 9,014
Other accrued liabilities 40,000 40,000
------------- ---------------
$ 1,533,953 $ 1,138,854
============= ===============
Warranty:
The warranty periods for the Company's products are generally one year from the
date of acceptance, but no longer than eighteen months from the date of
delivery. The Company is responsible for warranty obligations arising from its
sales and provides for an estimate of its warranty obligation at the time of
sale. The Company's contract manufacturers are responsible for the costs of any
manufacturing defects. Management estimates and provides a reserve for warranty
upon sale of a new machine based on historical warranty repair expenses of the
Company's installed base.
The following table summarizes the activity related to the product warranty
liability, which was included in accrued liabilities above.
December 31, September 30,
2009 2009
--------------- ----------------
Warranty accrual at the beginning of period $ 167,428 $ 161,947
Accrual for warranties during the period - 180,000
Actual product warranty expenditures (54,430) (174,519)
--------------- ----------------
Warranty accrual at the end of the period $ 112,998 $ 167,428
=============== ================
Q-16
NOTE 4 - BORROWINGS
Outstanding notes payable were as follows:
December 31, September 30,
2009 2009
-------------- ---------------
Notes payable, related parties, current $ 119,002 $ 119,002
============== ===============
Product financing arrangement $ 3,663,644 $ 4,519,955
Leased asset financing arrangement 1,150,000 1,150,000
Senior secured debentures 4,600,000 4,200,000
Other notes 44,367 244,367
-------------- ---------------
9,458,011 10,114,322
Less debt discounts due to warrants - (298,864)
-------------- ---------------
Notes payable, net of debt discounts 9,458,011 9,815,458
Less: current portion (9,458,011) (9,815,458)
-------------- ---------------
Notes payable, other, net of current portion and unamortized
debt discounts $ - $ -
Notes payable, related parties:
Notes payable to related parties of $119,002 at December 31, 2009 and September
30, 2009, is related to a promissory note issued to an officer of the Company.
The note is due on demand and bears interest at 9% per annum.
Product financing arrangements:
In August 2005, the Company entered into a $3,000,000 revolving combined
inventory financing and accounts receivable factoring agreement (the "Product
Financing Arrangement") with a financial institution. Under the terms of the
agreement, the Company agreed to pay interest at the rate of 12% per annum on
inventory financing and 24% per annum on accounts receivable financing under the
agreement. The loan is secured by a lien on the financed inventory and
receivables. In April 2006, the Company entered into an amendment to the
Product Financing Arrangement to clarify and amend certain terms and conditions
pursuant to which the Company can obtain financing under the agreement. Pursuant
to the amendment, ownership of the inventory financed is transferred to the
lender. From time to time, the Company may repurchase financed inventory from
the lender at a price equal to the original transfer price plus accrued
interest.
On September 17, 2007, the Company entered into amendment to the Product
Financing Arrangement to increase the availability under the agreement to
$6,000,000 and to extend the term of the agreement to September 16, 2009. The
Company also agreed to issue an additional warrant to purchase 27,000 shares of
common stock to the lender with an exercise of price of $4.00 per share and a
term of five years. The fair value of $103,990 attributable to the warrant was
recorded as a note discount and was amortized into interest expense.
Q-17
NOTE 4 - BORROWINGS (CONTINUED)
On July 3, 2008 the Company entered into an amendment to the Product Financing
Arrangement, to increase by approximately six months the amount of time certain
inventory may remain as collateral under the Purchase Agreement. The Company
agreed to reduce the exercise price of 27,000 warrants from $4.00 to $3.25 per
share, which warrants were previously issued on September 17, 2007. The fair
value of $99 attributable to the warrant was recorded as a note discount and was
amortized to interest.
In May 2009 the Company terminated and replaced its accounts receivable
factoring portion of its Product Financing Arrangement with a new financial
institution. The terms of this new agreement are similar to the previous
agreement, as borrowings there under bear interest at 24% per annum.
On June 30, 2009, pursuant to an amendment to the debenture purchase agreement
dated September 30, 2008, as previously amended on April 9, 2009, the Company
agreed to reduce the exercise price of 21,670 warrants issued on August 17, 2007
from $4.00 to $1.40, and also the exercise price of 27,000 warrants issued on
September 17, 2007 from $3.25 to $1.40. The change in the fair value of $897
attributable to the warrant repricing was recorded as a note discount and was
amortized to interest over the remaining term.
At December 31, 2009 the outstanding principal balance under the Product
Financing Arrangement was $3,663,644.
Senior secured debentures
The Company calculates the fair value of warrants issued with convertible
securities using the Black Scholes valuation method. The total proceeds received
in the sale of preferred stock or debt and related warrants is allocated among
these financial instruments based on their relative fair values. The debt
discount arising from assigning a portion of the total proceeds to the warrants
issued is recognized as interest expense from the date of issuance to the
earlier of the maturity date of the debt or the conversion dates using the
effective yield method. Additionally, when issuing convertible debt, including
convertible debt issued with detachable warrants, the Company tests for the
existence of a beneficial conversion feature in accordance with ASC 470-20
(previously FASB Emerging Issues Task Force Issue No. 98-5, Accounting for
Convertible Securities with Beneficial Conversion Features or Contingently
Adjustable Conversion Ratios, and FASB EITF No. 00-27, Application of Issue No.
98-5 to Certain Convertible Instruments (EITF No. 00-27)). The Company records
the amount of any beneficial conversion feature ("BCF"), calculated in
accordance with these accounting standards, whenever it issues convertible debt
that has conversion features at fixed rates that are in the money using the
effective per share conversion price when issued. The calculated amount of the
BCF is accounted for as a contribution to additional paid-in capital and as a
debt discount that is recognized as interest expense from the date of issuance
to the earlier of the maturity date of the debt or the conversion dates using
the effective yield method. The maximum amount of BCF that can be recognized is
limited to the amount that will reduce the net carrying amount of the debt to
zero.
Q-18
NOTE 4 - BORROWINGS (CONTINUED)
As of December 31, 2009 the Company has issued 10% senior secured debentures in
an aggregate principal amount of $4,600,000 to six private accredited investors
and lenders (collectively "Lenders"), and may issue up to $400,000 aggregate
principal amount of such debentures in the future under the terms of the
debenture purchase agreement that we have entered into with such Lenders. These
debentures mature on the earlier of (i) January 31, 2010 or (ii) the date the
Company closes an issuance, or series of issuances, of promissory notes
convertible into shares of its common stock with gross aggregate proceeds
received by the Company of not less than $6,000,000 (other than the 10% senior
secured debentures). The 10% senior secured debentures will convert at the
option of the holder into shares of preferred stock in the event that we close
an issuance, or series of issuances, of shares of preferred stock with gross
aggregate proceeds received by us of not less than $1,000,000 at a conversion
price equal to the price per share paid by the investors purchasing such
securities. Interest on the outstanding principal amount of the debentures
accrues at 10% per annum, payable monthly. The 10% senior secured debentures are
secured by a lien on all of our assets not otherwise pledged under our Product
Financing Arrangement.
The proceeds are to be used for working capital purposes.
Pursuant to ASC 470-20, the Company considered the potential contingent effect
of a beneficial conversion feature of the 10% senior secured debentures issued
during the three months ended December 31, 2009. Accordingly, the contingent
conversion option is not required to be recognized unless the triggering event
occurs and the contingency is resolved, and neither has occurred as of December
31, 2009.
Additionally, the Company granted warrants to these debenture holders to
purchase 821,419 shares of common stock at an exercise price of $1.40 per share
with expiration date ranging from March 31, 2014 to December 8, 2014. The
Company calculated the value of the warrants at the date of the transaction,
being approximately $878,277 under the Black-Scholes option-pricing method. The
Company allocated the $4.6 million in gross proceeds between the convertible
debentures and the warrants based on their fair values. The Company has reported
the debt discount as a direct reduction to the face amount of the debt. The
discount had accreted over the life of the outstanding debentures. The values
allocated to the warrants were recorded as a credit to additional paid in
capital.
Other notes:
The Company has a promissory note payable to a former director with an
outstanding principal balance of $44,367 at December 31, 2009. This note is due
on demand and bears interest at 9% per annum.
Q-19
NOTE 5 - CAPITAL LEASE
Capital lease
The Company leases equipment which is classified as capital lease arrangements.
Capital lease obligations were as follows:
December 31, September 30,
2009 2009
-------------- --------------
Capital lease for equipment $ 2,326 $ 2,946
Less: current portion (2,326) (2,519)
-------------- --------------
Capital lease obligations, net of current portion $ - $ 427
============== ==============
NOTE 6 - COMMON STOCK
Shares Reserved for Future Issuance:
The Company has reserved shares of common stock for future issuance as follows:
December 31, September 30,
2009 2009
-------------- -------------
2005 Equity Incentive Plan 907,193 907,193
Common stock warrants 1,143,878 1,072,451
-------------- -------------
Total 2,051,071 1,979,644
============== =============
At the Company's annual meeting of stockholders on October 15, 2007,
stockholders approved an amendment to the Company's 2005 Equity Incentive Plan
(the "Plan") to increase by 441,253 shares the number of shares of common stock
reserved for issuance under the Plan. Further at the Company's annual meeting
of stockholders on April 23, 2008, stockholders approved an amendment to the
Plan to increase the number of shares of common stock reserved for issuance
under the Plan by an additional 400,000 shares.
Q-20
NOTE 7 - STOCK OPTIONS
The table below summarizes the share-based compensation expense under ASC No.
718-10:
Three months ended
December 31,
------------------------
2009 2008
------------ -----------
Cost of revenues - Service $ 3,607 $ 8,569
Research and development 44,964 82,444
General and administrative 34,245 61,735
Sales and marketing 41,650 123,905
------------ -----------
Total $ 124,466 $ 276,653
============ ===========
During the three months ended December 31, 2009 and 2008, total share-based
compensation expense recognized in earnings before taxes was $124,466 and
$276,653 respectively and the total related recognized tax benefit was zero.
Additionally, total share-based compensation expense capitalized as part of
inventories for the three months ended December 31, 2009 and 2008 was $21,663
and $39,649 respectively, and total share-based compensation expense applied to
warranty reserve for the three months ended December 31, 2009 and 2008 was
$2,876 and $7,385 respectively.
No new options were issued during the three months ended December 31, 2009. The
fair values of options granted under the Plan for the three months ended
December 31, 2008 were estimated at the date of grant using the Black-Scholes
model with the following weighted average assumptions:
Three months ended
December 31,
2009 2008
---------- -----------
Expected term (in years) - 5.45
Risk-free interest rate - 2.63%
Expected volatility - 284%
Expected dividend yield - 0%
Weighted average fair value at grant date - $ 0.15
Q-21
NOTE 7 - STOCK OPTIONS (CONTINUED)
Activity under the Plan is presented below:
Weighted
Average
Weighted Remaining Aggregate
Average Contractual Intrinsic
Shares Available Number of Exercise Term Value
for Grant Shares Price (in years) (1)
----------------- --------------- -------------- ------------ -----------
Balance at September 30, 2008 290,324 616,869 $ 8.42 8.08
Granted (56,600) 56,600 1.44 -
Authorized - - - -
Cancelled or expired 82,248 (82,248) (8.67) -
Exercised - - - -
----------------- ---------------
Balance at September 30, 2009 315,972 591,221 $ 7.71 8.28 $ 59,900
Granted - - -
Authorized - - -
Cancelled or expired - - -
Exercised - - -
----------------- ---------------
Balance at December 31, 2009 315,972 591,221 $ 7.71 8.03 $ 0
================= ===============
Exercisable at December 31, 2009 450,816 $ 7.62 8.02 $ 0
===============
(1) The aggregate intrinsic value represents the total pre-tax intrinsic value,
which is computed based on the difference between the exercise price and the
Company's closing stock price of $0.45 as of December 31, 2009, which would
have been received by the option holders had all option holders exercised their
options as of that date.
As of December 31, 2009 there was approximately $194,508 of total unrecognized
compensation expense related to outstanding stock options. This unrecognized
compensation expense is expected to be recognized over a weighted average period
of 1.5 years.
Q-22
NOTE 7 - STOCK OPTIONS (CONTINUED)
Total options under the Plan at December 31, 2009, were as follows:
Weighted
Options Average Options
Option Outstanding Remaining Exercisable
Exercise as of Contractual as of
Price December 31, 2009 Life (Years) December 31, 2009
---------- ------------------ --------------- ------------------
$1.40 36,000 9.10 36,000
1.50 20,000 9.74 12,000
2.00 600 8.79 483
4.00 10,900 8.23 10,900
4.50 66,600 8.42 50,783
9.00 456,511 7.81 340,040
40.00 160 2.22 160
62.50 450 4.82 450
------------------
Total 591,221 450,816
================== ==================
Total options under the Plan at September 30, 2009, were as follows:
Options
Options Weighted Average Exercisable
Option Outstanding Remaining as of
Exercise as of Contractual September 30,
Price September 30, 2009 Life (Years) 2009
---------- ------------------ ---------------- -----------------
$1.40 36,000 9.35 33,000
1.50 20,000 9.99 6,667
2.00 600 9.04 283
4.00 10,900 8.48 7,844
4.50 66,600 8.68 28,583
9.00 456,511 8.06 225,478
40.00 160 2.47 160
62.50 450 5.08 450
-----------------
Total 591,221 302,465
================= =================
Q-23
NOTE 8 - WARRANTS
The following warrants are each exercisable for one share of common stock:
Weighted
Number of Average Aggregate
Shares Price Price
------------- ----------- -----------
Balance at September 30, 2008 325,839 $ 7.01 $2,284,821
Warrants granted 798,661 1.40 1,118,125
Warrants exercised - - -
Warrants cancelled (48,669) (3.58) (174,426)
Warrants expired (3,380) (30.44) (102,875)
------------- ----------- -----------
Balance at September 30, 2009 1,072,451 $ 2.91 $3,125,645
Warrants granted 71,427 1.40 99,998
Warrants exercised - - -
Warrants cancelled - - -
Warrants expired - - -
------------- ----------- -----------
Balance at December 31, 2009 1,143,878 $ 2.82 $3,225,643
============= =========== ===========
The common stock warrants as of December 31, 2009 and September 30, 2009 are
comprised of the following:
Warrants Weighted Average
Outstanding Remaining
as of Contractual Life
Exercise Price December 31, 2009 (Years)
--------------- ------------------- ------------------
$1.40 870,088 4.25
4.00 225,510 2.57
14.00 8,000 2.50
20.00 33,498 0.84
35.00 2,382 0.67
50.00 2,000 1.27
57.50 2,000 1.87
62.50 400 0.15
-------------------
Total 1,143,878
===================
Q-24
NOTE 8 - WARRANTS (CONTINUED)
Warrants Weighted Average
Outstanding Remaining
as of Contractual Life
Exercise Price September 30, 2009 (Years)
--------------- ------------------- ---------------------
$1.40 798,661 4.44
4.00 225,510 2.82
14.00 8,000 2.75
20.00 33,498 1.09
35.00 2,382 0.92
50.00 2,000 1.52
57.50 2,000 2.12
62.50 400 0.40
-------------------
Total 1,072,451
===================
During the following fiscal years, the numbers of warrants to purchase common
stock which will expire in the next five years if unexercised are:
Fiscal Year
Ending Number
September 30,
--------------- ----------------
2010 40,916
2011 17,748
2012 263,795
2013 -
2014 821,419
----------------
1,143,878
================
NOTE 9 - EMPLOYEE BENEFIT PLAN
The Company maintains a 401(k) defined contribution plan that covers
substantially all of its employees. Participants may elect to contribute up to
the maximum limit imposed by federal tax law. The Company, at its discretion,
may make annual matching contributions to the plan. The Company has made no
matching contributions to the plan through December 31, 2009.
Q-25
NOTE 10 - OPERATING SEGMENT AND GEOGRAPHIC INFORMATION
Net revenues by geographic area are presented as follows, with no other
geographic region representing 10% or more of net revenues during the periods
presented.
Three months ended
December 31,
-------------------------------
2009 2008
-------------- --------------
Europe $ 47,921 $ 1,032,419
Asia - -
United States 111,843 96,847
South America 1,302 69,000
-------------- --------------
Total Revenue $ 161,066 $ 1,198,266
============== ==============
The Company maintained long lived assets includes property and equipment,
intangible assets, and leased equipment each net of applicable depreciation or
amortization in the following geographic areas during the three months ended
December 31, 2009:
Three months ended
December 31, 2009
------------------------
United States $ 1,048,744
Europe 1,688
Asia 2,891
------------------------
Total $ 1,053,323
========================
NOTE 11 - SUBSEQUENT EVENTS
The Company evaluates events that occur subsequent to the balance sheet date of
periodic reports, but before financial statements are issued for periods ending
on such balance sheet dates, for possible adjustment to such financial
statements or other disclosure. This evaluation generally occurs through the
date at which the Company's financial statements are electronically prepared for
filing with the SEC. For the financial statements as of and for the periods
ending December 31, 2009, this date was February 12, 2010.
In January 2010 the Company issued $400,000 under the 10% senior secured
debentures (the "Debentures") with a due date of July 31, 2010 to certain
related parties. The Company has board approval to issue another $2,500,000
under this facility, as amended as described below.
Q-26
NOTE 11 - SUBSEQUENT EVENTS (CONTINUED)
On January 31, 2010, the Company entered into an amendment to the Debenture
Purchase Agreement (the "Purchase Agreement") dated as of September 30, 2008 and
previously amended as of April 9, 2009, June 30, 2009 and December 31, 2009,
with the purchasers of Debentures (the "Debenture Purchasers"). In connection
with this amendment, the Company repaid the Debenture having an aggregate
principal amount of $500,000 held by E.U. Capital and concurrently sold
Debentures having a principal amount of $250,000 to each of Mr. Morkner, who is
a new Debenture Purchaser, and Mr. Ralls. As of January 31, 2010, an aggregate
of $5,000,000 in principal amount of Debentures had been issued to the Debenture
Purchasers and remained outstanding.
In connection with the amendment to the Purchase Agreement, the Company and the
Debenture Purchasers also agreed to amend the form of each of the previously
issued Debentures and each additional Debenture to be issued under the Purchase
Agreement in the future in order to extend the maturity date of such Debentures
from January 31, 2010 to July 31, 2010
Concurrently with the issuance of the Debentures described above to Messrs.
Ralls and Morkner, the Company issued warrants to purchase 44,642 shares of
common stock to each of those Debenture Purchasers.
Q-2
