Attached files
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EX-32.1 - 091231_IMX_FORM 10Q_EX 32.1 - SECURE POINT TECHNOLOGIES INC | imxform10q_091231ex32-1.htm |
EX-31.2 - 091231_IMX_FORM 10Q_EX 31.2 - SECURE POINT TECHNOLOGIES INC | imxform10q_091231ex31-2.htm |
EX-32.2 - 091231_IMX_FORM 10Q_EX 32.2 - SECURE POINT TECHNOLOGIES INC | imxform10q_091231ex32-2.htm |
EX-31.1 - 091231_IMX_FORM 10Q_EX 31.1 - SECURE POINT TECHNOLOGIES INC | imxform10q_091231ex31-1.htm |
UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
Form
10-Q
(Mark
One)
x QUARTERLY
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
For the
quarterly period ended December 31,
2009
or
o TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
For the
transition period
from
to
Commission
File Number: 001-14949
Implant
Sciences Corporation
(Exact
name of registrant as specified in our charter)
Massachusetts
(State
or other jurisdiction of
incorporation
or organization)
|
04-2837126
(I.R.S.
Employer Identification No.)
|
|
600
Research Drive, Wilmington, Massachusetts
(Address
of principal executive offices)
|
01887
(Zip
Code)
|
(978)
752-1700
(Registrant’s
telephone number, including area code)
(Former
name, former address and former fiscal year, if changed since last
report)
Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days.
Yes x No q
Indicate
by check mark whether the registrant has submitted electronically and posted on
our corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding
12 months (or for such shorter period that the registrant was required to submit
and post such files). Yes x No q
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting
company. See the definitions of “large accelerated filer,”
“accelerated filer” and smaller reporting company” in Rule 12b-2 of the Exchange
Act. (Check one):
q Large
Accelerated
Filer q Accelerated
Filer
q Non-accelerated
Filer x Smaller
reporting company
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act).Yes
q No
x
As of
February 19, 2010, there were 22,124,195 shares of the registrant’s Common Stock
outstanding.
TABLE
OF CONTENTS
Page
|
||
PART
I.
|
FINANCIAL
INFORMATION
|
|
Item
1.
|
Condensed
Consolidated Financial Statements (unaudited)
|
|
Condensed
Consolidated Balance Sheets at December 31, 2009 and June 30,
2009
|
3
|
|
Condensed
Consolidated Statements of Operations for the three and
six months ended
December
31, 2009 and 2008
|
4
|
|
Condensed
Consolidated Statements of Cash Flows for the six months
ended
December
31, 2009 and 2008
|
5
|
|
Notes
to Condensed Consolidated Financial Statements
|
6-27
|
|
Item
2.
|
Management’s
Discussion and Analysis of Financial Condition and Results of
Operations
|
28-43
|
Item
3.
|
Quantitative
and Qualitative Disclosures About Market Risk
|
44
|
Item
4.
|
Controls
and Procedures
|
44
|
PART
II.
|
OTHER
INFORMATION
|
|
Item
1.
|
Legal
Proceedings
|
45
|
Item
1A.
|
Risk
Factors
|
45
|
Item
2.
|
Unregistered
Sales of Equity Securities and Use of Proceeds
|
45
|
Item
3.
|
Defaults
Upon Senior Securities
|
46
|
Item
4.
|
Submission
of Matters to a Vote of Security Holders
|
46
|
Item
5.
|
Other
Information
|
46
|
Item
6.
|
Exhibits
|
47
|
Signatures
|
48
|
-2-
Implant
Sciences Corporation
|
||||||||
Condensed
Consolidated Balance Sheets
|
||||||||
December
31,
|
June
30,
|
|||||||
2009
|
2009
|
|||||||
(Unaudited)
|
(Audited)
|
|||||||
ASSETS
|
||||||||
Current
assets:
|
||||||||
Cash
and cash equivalents
|
$ | 25,000 | $ | - | ||||
Restricted
cash
|
537,000 | 664,000 | ||||||
Accounts
receivable-trade, net of allowance of $96,000 and
$65,000, respectively
|
115,000 | 201,000 | ||||||
Accounts
receivable, unbilled
|
29,000 | 138,000 | ||||||
Note
receivable
|
172,000 | 167,000 | ||||||
Inventories
|
241,000 | 561,000 | ||||||
Prepaid
expenses and other current assets
|
216,000 | 518,000 | ||||||
Current
assets held for sale
|
103,000 | 169,000 | ||||||
Total
current assets
|
1,438,000 | 2,418,000 | ||||||
Property
and equipment, net
|
212,000 | 276,000 | ||||||
Note
receivable
|
671,000 | 766,000 | ||||||
Other
non-current assets
|
18,000 | 68,000 | ||||||
Goodwill
|
3,136,000 | 3,136,000 | ||||||
Total
assets
|
$ | 5,475,000 | $ | 6,664,000 | ||||
LIABILITIES
AND STOCKHOLDERS' (DEFICIT) EQUITY
|
||||||||
Current
liabilities:
|
||||||||
Cash
overdraft
|
$ | - | 6,000 | |||||
Senior
secured convertible note
|
4,480,000 | 4,049,000 | ||||||
Senior
secured note
|
1,000,000 | - | ||||||
Line
of credit
|
1,819,000 | - | ||||||
Current
maturities of long-term debt and obligations under capital
lease
|
24,000 | 27,000 | ||||||
Notes
payable
|
100,000 | 100,000 | ||||||
Payable
to Med-Tec
|
55,000 | 56,000 | ||||||
Accrued
expenses
|
1,796,000 | 1,968,000 | ||||||
Accounts
payable
|
3,400,000 | 4,337,000 | ||||||
Current
portion of long-term lease liability
|
- | 334,000 | ||||||
Derivatives
|
- | - | ||||||
Deferred
revenue
|
191,000 | 428,000 | ||||||
Current
liabilities held for sale
|
63,000 | 107,000 | ||||||
Total
current liabilities
|
12,928,000 | 11,412,000 | ||||||
Long-term
liabilities:
|
||||||||
Long-term
debt and obligations under capital lease, net of current
maturities
|
67,000 | 86,000 | ||||||
Long-term
lease liability
|
- | 84,000 | ||||||
Total
long-term liabilities
|
67,000 | 170,000 | ||||||
Total
liabilities
|
12,995,000 | 11,582,000 | ||||||
Commitments
and contingencies
|
||||||||
Series
E Convertible Preferred Stock, $5 stated value; 1,000,000
shares
|
||||||||
authorized,
1,000,000 shares outstanding (liquidation value
$5,000,000)
|
5,000,000 | 5,000,000 | ||||||
Series
F Convertible Preferred Stock, no stated value; 2,000,000
shares
|
||||||||
authorized,
1,646,663 shares outstanding (liquidation value $378,000)
|
378,000 | - | ||||||
Stockholders'
(deficit) equity:
|
||||||||
Common
stock; $0.10 par value; 50,000,000 shares authorized; 17,634,740
and
17,624,195
at December 31, 2009 and 15,434,740 and 15,424,195 at June 30, 2009 shares
issued and outstanding, respectively
|
1,763,000 | 1,543,000 | ||||||
Additional
paid-in capital
|
61,452,000 | 61,290,000 | ||||||
Accumulated
deficit
|
(75,951,000 | ) | (72,678,000 | ) | ||||
Deferred
compensation
|
(89,000 | ) | - | |||||
Treasury
stock, 10,545 common shares, respectively, at cost
|
(73,000 | ) | (73,000 | ) | ||||
Total
stockholders' (deficit) equity
|
(12,898,000 | ) | (9,918,000 | ) | ||||
Total
liabilities and stockholders' (deficit) equity
|
$ | 5,475,000 | $ | 6,664,000 | ||||
The
accompanying notes are an integral part of these financial
statements.
|
-3-
Implant
Sciences Corporation
|
||||||||||||||||
Condensed
Consolidated Statements of Operations
|
||||||||||||||||
(Unaudited)
|
||||||||||||||||
For
the Three Months Ended
|
For
the Six Months Ended
|
|||||||||||||||
December
31,
|
December
31,
|
|||||||||||||||
2009
|
2008
|
2009
|
2008
|
|||||||||||||
Revenues:
|
||||||||||||||||
Security
products
|
$ | 496,000 | $ | 1,207,000 | $ | 2,131,000 | $ | 6,509,000 | ||||||||
Government
contracts and services
|
107,000 | 312,000 | 292,000 | 958,000 | ||||||||||||
603,000 | 1,519,000 | 2,423,000 | 7,467,000 | |||||||||||||
Cost
of revenues
|
477,000 | 881,000 | 1,456,000 | 4,053,000 | ||||||||||||
Gross
margin
|
126,000 | 638,000 | 967,000 | 3,414,000 | ||||||||||||
Operating
expenses:
|
||||||||||||||||
Research
and development
|
576,000 | 751,000 | 1,171,000 | 1,771,000 | ||||||||||||
Selling,
general and administrative
|
842,000 | 1,561,000 | 2,069,000 | 3,927,000 | ||||||||||||
Lease
termination benefit
|
(384,000 | ) | - | (384,000 | ) | - | ||||||||||
1,034,000 | 2,312,000 | 2,856,000 | 5,698,000 | |||||||||||||
Loss
from operations
|
(908,000 | ) | (1,674,000 | ) | (1,889,000 | ) | (2,284,000 | ) | ||||||||
Other
income (expense), net:
|
||||||||||||||||
Interest
income
|
14,000 | 12,000 | 32,000 | 20,000 | ||||||||||||
Interest
expense
|
(730,000 | ) | (773,000 | ) | (1,396,000 | ) | (805,000 | ) | ||||||||
Derivatives
mark-to-market
|
- | - | - | - | ||||||||||||
Gain
on transfer of investment
|
- | (123,000 | ) | - | (123,000 | ) | ||||||||||
Realized
losses in unconsolidated subsidiary
|
- | 468,000 | - | 468,000 | ||||||||||||
Total
other income (expense), net
|
(716,000 | ) | (416,000 | ) | (1,364,000 | ) | (440,000 | ) | ||||||||
Loss
from continuing operations
|
(1,624,000 | ) | (2,090,000 | ) | (3,253,000 | ) | (2,724,000 | ) | ||||||||
Preferred
distribution, dividends and accretion
|
- | (18,000 | ) | - | (207,000 | ) | ||||||||||
Loss
from continuing operations applicable to common
shareholders
|
(1,624,000 | ) | (2,108,000 | ) | (3,253,000 | ) | (2,931,000 | ) | ||||||||
Income
(loss) income from discontinued operations, before sale of
discontinued operations
|
- | 7,000 | (20,000 | ) | 997,000 | |||||||||||
Gain
on sale of Core Systems
|
- | 22,000 | - | 22,000 | ||||||||||||
Net
income (loss) from discontinued operations
|
- | 29,000 | (20,000 | ) | 1,019,000 | |||||||||||
Net
loss applicable to common shareholders
|
$ | (1,624,000 | ) | $ | (2,079,000 | ) | $ | (3,273,000 | ) | $ | (1,912,000 | ) | ||||
Net
loss
|
$ | (1,624,000 | ) | $ | (2,061,000 | ) | $ | (3,273,000 | ) | $ | (1,705,000 | ) | ||||
Loss
per share from continuing operations, basic and diluted
|
$ | (0.10 | ) | $ | (0.15 | ) | $ | (0.21 | ) | $ | (0.20 | ) | ||||
Loss
per share from continuing operations applicable to common
shareholders,
basic and diluted
|
$ | (0.10 | ) | $ | (0.15 | ) | $ | (0.21 | ) | $ | (0.21 | ) | ||||
(Loss)
income per share from discontinued operations, basic and
diluted
|
$ | 0.00 | $ | 0.00 | $ | (0.00 | ) | $ | 0.07 | |||||||
Net
loss per share applicable to common shareholders, basic and
diluted
|
$ | (0.10 | ) | $ | (0.15 | ) | $ | (0.21 | ) | $ | (0.14 | ) | ||||
Net
loss per share
|
$ | (0.10 | ) | $ | (0.15 | ) | $ | (0.21 | ) | $ | (0.12 | ) | ||||
Weighted
average shares used in computing net loss per common share, basic and
diluted
|
16,157,529 | 14,135,155 | 15,790,862 | 13,801,822 |
The
accompanying notes are an integral part of these financial
statements.
-4-
Implant
Sciences Corporation
|
||||||||
Condensed
Consolidated Statements of Cash Flows
|
||||||||
(Unaudited)
|
||||||||
For
The Six Months Ended December 31,
|
||||||||
2009
|
2008
|
|||||||
Cash
flows from operating activities:
|
||||||||
Net
loss
|
$ | (3,273,000 | ) | $ | (1,705,000 | ) | ||
Less: Net
(loss) income from discontinued operations
|
(20,000 | ) | 1,019,000 | |||||
Loss
from continuing operations
|
(3,253,000 | ) | (2,724,000 | ) | ||||
Adjustments
to reconcile net loss from continuing operations to net cash
flows:
|
||||||||
Depreciation
and amortization
|
67,000 | 145,000 | ||||||
Bad
debt expense (recoveries)
|
28,000 | 4,000 | ||||||
Share-based
compensation expense
|
79,000 | 147,000 | ||||||
Fair
value of common stock issued to consultants
|
63,000 | - | ||||||
Loss
on disposal of fixed assets
|
- | 10,000 | ||||||
Non-cash
interest expense
|
868,000 | 639,000 | ||||||
Fair
value of warrants issued to non-employees
|
16,000 | (21,000 | ) | |||||
Warrant
accretion on debt
|
71,000 | 17,000 | ||||||
Lease
liability termination benefit
|
(384,000 | ) | - | |||||
Derivatives
mark-to-market
|
- | - | ||||||
Realized
losses in unconsolidated subsidiaries
|
123,000 | |||||||
Gain
on transfer of investment
|
(468,000 | ) | ||||||
Interest
income on note receivable
|
(6,000 | ) | ||||||
Changes
in assets and liabilities, net of effect of divestitures:
|
||||||||
Accounts
receivable
|
167,000 | (135,000 | ) | |||||
Inventories
|
305,000 | 107,000 | ||||||
Prepaid
expenses and other current assets
|
307,000 | (331,000 | ) | |||||
Cash
overdraft
|
(6,000 | ) | - | |||||
Accounts
payable
|
(935,000 | ) | 778,000 | |||||
Accrued
expenses
|
(172,000 | ) | (375,000 | ) | ||||
Deferred
revenue
|
(237,000 | ) | 39,000 | |||||
Lease
liability
|
- | (185,000 | ) | |||||
Net
cash used in operating activities of continuing operations
|
(3,016,000 | ) | (2,236,000 | ) | ||||
Net
cash provided by operating activities of discontinued
operations
|
17,000 | 36,000 | ||||||
Net
cash used in operating activities
|
(2,999,000 | ) | (2,200,000 | ) | ||||
Cash
flows from investing activities:
|
||||||||
Purchases
of property and equipment
|
(3,000 | ) | (26,000 | ) | ||||
Transfer
from restricted funds, net
|
127,000 | - | ||||||
Proceeds
from sale of property and equipment, net of transaction
costs
|
- | 1,457,000 | ||||||
Proceeds
from the sale of Core Systems, net of transaction costs
|
1,080,000 | |||||||
Payments
received on note receivable
|
90,000 | 375,000 | ||||||
Increase
in other non-current assets
|
- | (14,000 | ) | |||||
Net
cash provided by investing activities of continuing
operations
|
214,000 | 2,872,000 | ||||||
Net
cash used in investing activities of discontinued
operations
|
- | (28,000 | ) | |||||
Net
cash provided by investing activities
|
214,000 | 2,844,000 | ||||||
Cash
flows from financing activities:
|
||||||||
Proceeds
from common stock issued in connection with exercise of stock
options and employee stock purchase plan
|
- | 24,000 | ||||||
Proceeds
from the issuance of Senior Secured Promissory Notes
|
1,000,000 | 4,484,000 | ||||||
Principal
payment on Senior Secured Convertible Promissory Note
|
(1,000,000 | ) | ||||||
Dividends
on Series D Convertible Preferred Stock
|
- | (52,000 | ) | |||||
Payments
on Series D Convertible Preferred Stock
|
- | (2,724,000 | ) | |||||
Principal
repayments of long-term debt and capital lease obligations
|
(9,000 | ) | (299,000 | ) | ||||
Net
borrowings (repayments) on line of credit
|
1,819,000 | (764,000 | ) | |||||
Net
cash provided by (used in) financing activities of continuing
operations
|
2,810,000 | (331,000 | ) | |||||
Net
cash used in discontinued operations
|
- | (1,000 | ) | |||||
Net
cash provided by (used in) financing activities
|
2,810,000 | (332,000 | ) | |||||
Net
change in cash and cash equivalents
|
25,000 | 312,000 | ||||||
Cash
and cash equivalents at beginning of period
|
- | 412,000 | ||||||
Cash
and cash equivalents at end of period
|
$ | 25,000 | $ | 724,000 | ||||
Supplemental
Disclosure of Cash Flow Information:
|
||||||||
Interest
paid
|
$ | 160,000 | $ | 159,000 |
The
accompanying notes are an integral part of these financial
statements.
-5-
IMPLANT
SCIENCES CORPORATION
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS
1. Description
of Business
Implant
Sciences Corporation provides systems and sensors for the homeland security
market and related industries. We have developed and acquired
technologies using ion mobility spectrometry to develop a product line for use
in trace explosives detection. We currently market and sell our
existing trace explosives detector products while continuing to make significant
investments in developing the next generation of these products.
Acquisition
of Ion Metrics
In April
2008, we acquired all of the capital stock of Ion Metrics, Inc. Ion
Metrics was in the business of producing low-cost mass sensor systems for the
detection and analysis of chemical compounds such as explosives, chemical
warfare agents, narcotics, and toxic industrial chemicals for the homeland
defense, forensic, environmental, and safety/security markets. The transaction
was structured as a reorganization of Ion Metrics with and into our newly
formed, wholly-owned subsidiary. The total purchase price, including $564,000 of
assumed liabilities, was approximately $3,309,000. As part of the
transaction, we issued to the former stockholders of Ion Metrics consideration
consisting of 2,000,000 shares of our common stock, par value $0.10 per share.
The integration of the Ion Metrics technologies into our Quantum SnifferTM
product line is expected to provide opportunities to introduce smaller,
lower-cost, and higher performance security solutions.
Sale
of Accurel
In May
2007, we sold substantially all of the assets of our Accurel Systems subsidiary
to Evans Analytical Group, LLC for approximately $12,705,000, including
$1,000,000 held by an escrow agent as security for certain representations and
warranties. In February 2008, Evans filed suit in the Superior Court
of the State of California, Santa Clara County, requesting rescission of the
asset purchase agreement, plus damages, based on claims of misrepresentation and
fraud. In March 2008, Evans filed a notice with the escrow agent
prohibiting release of any portion of the escrow to us pending resolution of the
lawsuit. In March 2009, we announced the settlement of this
litigation and the mutual release by us and Evans of all claims related to the
sale of Accurel. In settling this litigation, we agreed to pay Evans
damages in the amount of approximately $5,700,000 by (i) agreeing to release to
Evans approximately $700,000 that had been held in escrow since the time of the
closing of the Accurel sale and (ii) agreeing to issue to Evans 1,000,000 shares
of Series E Convertible Preferred Stock having an aggregate liquidation
preference of $5,000,000. In April 2009, $700,000 of the funds held
in escrow, together with accrued interest, was released to Evans and $300,000,
the balance of the escrow amount, was released to us.
Sale
of Core
In
November 2008, we entered into a definitive agreement, with Core Systems
Incorporated, an entity newly formed by the Subsidiary’s general manager and
certain other investors (the “Buyer”), to sell substantially all the assets of
our wholly owned semiconductor subsidiary, C Acquisition Corp., which had
operated under the name Core Systems (the “Subsidiary”), for a purchase price of
$3,000,000 plus the assumption of certain liabilities. The Buyer made
a cash down payment of $250,000 prior to the execution of the definitive
agreement. On November 24, 2008, the parties amended the agreement
and completed the asset sale. On that date, the Buyer made a cash
payment of $1,125,000 and issued a promissory note in the amount of
$1,625,000. The promissory note required the Buyer to pay the
Subsidiary $125,000 on or before November 28, 2008, an additional $500,000 on or
before December 24, 2008, and the remaining principal balance, together with
accrued interest, in equal monthly installments over a period of 60 months
commencing on February 1, 2009. The Buyer and the Subsidiary also
executed a security agreement, pursuant to which the Buyer granted the
Subsidiary a security interest in all of the Buyer’s assets to secure our
obligations under the promissory note. The Buyer paid $250,000 of the
amount due in December and paid the remaining $250,000 balance due in March
2009.
Sale
of Medical Reporting Unit
In June
2007, we sold certain of the assets related to our brachytherapy products and
divested the prostate seed and medical software businesses. In March
2008, we informed our medical coatings customers of our intention to discontinue
coating operations by the end of the 2008 calendar year. During the
six months ended December 31, 2008, under three separate asset purchase
agreements, we sold certain assets of our medical coatings business, with gross
proceeds aggregating approximately $1,590,000. The Medical Reporting Unit is
reported as discontinued operations in the accompanying financial
statements.
-6-
IMPLANT
SCIENCES CORPORATION
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS
CorNova
We had
partnered with CorNova, Inc., a privately-held, development stage company
focused on the development of a next-generation drug-eluting stent, and were
issued 1,500,000 shares of CorNova’s common stock representing a 15% ownership
interest. On December 10, 2008, we transferred the CorNova shares in
connection with the issuance of the senior secured convertible promissory note
(See Note 13).
Risks and
Uncertainties
Despite
our current sales, expense and cash flow projections and the cash available from
our line of credit with DMRJ Group LLC, we require additional capital in the
fourth quarter of fiscal 2010 to repay our senior secured convertible promissory
note, secured promissory note and line of credit, each of which mature on June
10, 2010, to fund operations and continue the development, commercialization and
marketing of our products. Our failure to achieve our projections and/or obtain
sufficient additional capital on acceptable terms would have a material adverse
effect on our liquidity and operations and could require us to file for
protection under bankruptcy laws.
In
addition, while we strive to bring new products to market, we are subject to a
number of risks similar to the risks faced by other technology-based companies,
including risks related to: (a) our dependence on key individuals and
collaborative research partners; (b) competition from substitute products and
larger companies; (c) our ability to develop and market commercially usable
products and obtain regulatory approval for our products under development; and
(d) our ability to obtain substantial additional financing necessary to
adequately fund the development, commercialization and marketing of our
products. For the six months ended December 31, 2009, we reported a
net loss applicable to common shareholders of $3,273,000, a loss from continuing
operations of $3,253,000 and used $3,016,000 in cash from
operations. As of December 31, 2009, we had an accumulated deficit of
approximately $75,951,000 and a working capital deficit of
$11,490,000. Management continually evaluates plans to reduce our
operating expenses and increase our cash flow from
operations. Failure to achieve our projections may require us to seek
additional financing or discontinue operations.
Based on
current sales, operating expense and cash flow projections, and the cash
available from our line of credit, management believes there are plans in place
to sustain operations for the next several months. These plans depend
on a substantial increase in sales of our handheld trace explosives detector
product. To further sustain us, improve our cash position, and enable
us to grow while reducing debt, management plans to continue to seek additional
capital through private financing sources during the next three
months. However, there can be no assurance that management will be
successful in executing these plans. Management will continue to
closely monitor and attempt to control our costs and actively seek needed
capital through sales of our products, equity infusions, government grants and
awards, strategic alliances, and through our lending institutions.
We have
suffered recurring losses from operations. Our consolidated financial
statements have been presented on the basis that it is a going concern, which
contemplates the realization of assets and the satisfaction of liabilities in
the normal course of business.
There can
be no assurances that our forecasted results will be achieved or that we will be
able to raise additional capital necessary to operate our
business. These conditions raise substantial doubt about our ability
to continue as a going concern. The financial statements do not
include any adjustments relating to the recoverability and classification of
asset amounts or the amounts and classification of liabilities that might be
necessary should we be unable to continue as a going concern.
We have
experienced a reduction in security revenue in the six-month period ended
December 31, 2009 as compared with the comparable prior year period, relating to
a decline in unit sales of our trace explosives products. Security product sales
tend to have a long sale cycle, and are often subject to export
controls. In an effort to identify new opportunities and stimulate
sales, we have implemented a new sales tool to assist in this
effort. However, there can be no assurance that these efforts will
increase revenue.
We have a
history of being active in submitting proposals for government sponsored grants
and contracts and successful in being awarded grants and contracts from
government agencies. However, we have experienced a decline in government
contract revenue in the six month period ended December 31, 2009 as compared to
the comparable prior year period, due to the expiration of several contracts in
the six month period ended December 31, 2009. Management will
continue to pursue these grants and contracts to support our research and
development efforts primarily in the areas of trace explosives
detection.
-7-
IMPLANT
SCIENCES CORPORATION
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS
In June,
August, October and November 2008, we entered into a series of amendments,
waivers and modifications to our credit agreements with Bridge Bank, N.A.,
pursuant to which, in exchange for the payment by us of forbearance fees in the
amount of $90,000, the bank waived certain existing and anticipated defaults,
the bank reduced our credit line to $1,500,000 from $5,000,000, and extended the
modified facility through December 10, 2008. On December 10, 2008, we used
approximately $477,000 of the proceeds of the sale of the senior secured
convertible promissory note (see Note 13) to repay all of the indebtedness
outstanding to the bank and the credit facility was terminated. As of
December 31, 2009 and 2008, our obligation for borrowed funds under the credit
facility amounted to $0.
On
December 10, 2008, we entered into a note and warrant purchase agreement with
DMRJ Group LLC, an accredited institutional investor, pursuant to which we
issued a senior secured convertible promissory note in the principal amount of
$5,600,000 and a warrant to purchase 1,000,000 shares of our common
stock. The note, which is collateralized by all of our assets,
originally bore interest at 11.0% per annum. The effective interest
rate on the note as of the date of issuance was approximately
23.4%. We prepaid interest in the amount of $616,000 upon the
issuance of the note. In lieu of paying any commitment fees, closing
fees or other fees in connection with the purchase agreement, we transferred our
entire interest in 1,500,000 shares of the common stock of CorNova, Inc., a
privately-held development stage medical device company, to DMRJ. The
note, which has been amended and restated, as described below, was originally
convertible in whole or in part at the option of DMRJ into shares of our common
stock at a conversion price of $0.26 per share.
We valued
the note upon issuance at its residual value of $4,356,000 based on the fair
values of the financial instruments issued in connection with this convertible
debt financing, including the warrant, the original issue discount and the fair
value of the CorNova common stock transferred to DMRJ. The amounts
recorded in the financial statements represents the amounts attributed to the
senior secured convertible debt of $5,600,000, net of $160,000 allocated to the
warrant, $616,000 of original issue discount and $468,000 representing the
estimated fair value of the CorNova common stock. The warrant was
valued using the Black-Scholes model with the following
assumptions: volatility 98.4%, risk-free interest rate of 2.29%,
expected life of five years and expected dividend yield of 0.00%. As
required under the terms of the note, we made a principal payment of $1,000,000
on December 24, 2008. The note required us to make a principal
payment in an amount equal to any funds released from the escrow created in
connection with the May 2007 sales of the assets of Accurel Systems
International, upon the release of such funds. DMRJ
waived that requirement in connection with the settlement of the Evans
litigation.
The note
contains restrictions and financial covenants including: (i) restrictions
against declaring or paying dividends or making any distributions; against
creating, assuming or incurring any liens; against creating, assuming
or incurring any indebtedness; against merging or consolidating with any other
company, provided,
however, that a merger or consolidation is permitted if we are the
surviving entity; against the sale, assignment, transfer or lease of our assets,
other than in the ordinary course of business and excluding inventory and
certain asset sales expressly permitted by the note purchase agreement; against
making investments in any company, extending credit or loans, or purchasing
stock or other ownership interest of any company; and (ii) covenants that we
have authorized or reserved for the purpose of issuance, 150% of the aggregate
number of shares of our common stock issuable upon exercise of the
warrant; that we maintain a minimum cash balance of at least
$500,000; that the aggregate dollar amount of all accounts payable be
no more than 100 days past due; and that we maintain a current ratio, defined as
current assets divided by current liabilities, of no less than 0.60 to
1.00.
On March
12, 2009, we entered into a letter agreement with DMRJ pursuant to which we were
granted access to $250,000 of previously restricted cash out of funds held in a
blocked account. The effect of the letter agreement made $250,000
available to us until the close of business on April 14, 2009. In consideration
of the letter agreement, on March 12, 2009, we issued an amended and restated
senior secured convertible promissory note and amended and restated warrant to
DMRJ to purchase shares of common stock, which replaced the note and warrant
issued on December 10, 2008. The terms of the amended and restated
note and the amended and restated warrant are identical to the terms of the
original note and warrant, except that the amended instruments reduced the
initial conversion price of the original note from $0.26 to $0.18 and reduced
the initial exercise price of the original warrant from $0.26 to
$0.18.
On July
1, 2009, we entered into an amendment to the December 10, 2008 note and warrant
purchase agreement with DMRJ, pursuant to which we issued a senior secured
promissory note to DMRJ in the principal amount of $1,000,000.
-8-
IMPLANT
SCIENCES CORPORATION
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS
The note,
which has been amended, as described below, originally bore interest
at the rate of 2.5% per month. The principal balance of the note, together with
all outstanding interest and all other amounts owed under the note, was
originally due and payable on the earlier of (i) December 10, 2009 and (ii) the
receipt by us of net proceeds of at least $3,000,000 from the issuance of debt
and/or equity securities in one or more transactions. In addition, at our
option, DMRJ may require us to prepay such amounts upon (i) certain
consolidations, mergers and business combinations involving us; (ii) the sale or
transfer of more than 50% of our assets, other than inventory sold in the
ordinary course of business, in one or more related or unrelated transactions;
or (iii) the issuance by us, in one or more related or unrelated transactions,
of any equity securities or securities convertible into equity securities (other
than options granted to employees and consultants pursuant to employee benefit
plans approved by our Board of Directors), which results in net cash proceeds to
us of more than $500,000; provided, however, that DMRJ
may not require us to prepay more than the net cash proceeds of any transaction
described in the preceding clause (iii) of this sentence. We may prepay all or
any portion of the principal amount of the note, without penalty or premium,
after prior notice to DMRJ.
The
amendment to the loan agreement provides that, in the event we have not obtained
net proceeds from the issuance of debt or equity securities upon terms and
conditions acceptable to DMRJ in its sole discretion of (i) $1,000,000 by July
24, 2009 and (ii) to the extent that we satisfied such requirements, an
additional $2,000,000 by August 21, 2009, we will immediately engage in a sale
process satisfactory to DMRJ in its sole discretion by implementing a
contingency plan which may be established by DMRJ, including, without
limitation, the engagement at our expense of a third party investment banker
acceptable to DMRJ in its sole discretion. We did not satisfy these
requirements and, in August 2009, we engaged Pickwick Capital Partners to market
our company for sale.
In
connection with the additional note issued on July 1, 2009, we also issued
871,763 shares of our Series F Convertible Preferred Stock to DMRJ, and agreed
that, if we were unable to obtain net proceeds of at least $3,000,000 from the
issuance of debt and/or equity securities by August 31, 2009, we would issue
774,900 additional shares of Series F Preferred Stock to DMRJ. DMRJ later
extended this deadline until October 1, 2009. We did not satisfy this
requirement and, on October 1, 2009, we issued the additional shares to DMRJ.
All of the 1,646,663
shares of Series F Preferred Stock held by DMRJ are convertible into 25%
of our common stock, calculated on a fully diluted basis. In addition, for so
long as the July 2009 note or the amended and restated senior secured
convertible promissory note issued to DMRJ in March 2009 remain outstanding, we
may not issue additional shares of common stock, or other securities convertible
into or exercisable for common stock, if such securities would increase the
number of shares of our common stock, calculated on a fully diluted basis, unless we simultaneously
issue to DMRJ that number of additional shares of Series F Preferred Stock which
is necessary to result in the number of shares of common stock into which all
Series F Preferred Stock held by DMRJ may be converted representing the same
percentage ownership of our common stock on a fully diluted basis after such
issuance as immediately prior thereto. We calculated the value of the
Series F Preferred Stock to be $378,000, which amount represents 25% of the fair
value of the Company on the date of issuance based on the market capitalization
as of that date.
After the
repayment in full of the promissory notes, described above, the number of shares
of common stock into which the Series F Preferred Stock is convertible will
remain subject to “full ratchet” antidilution protection in the event that we
issue additional shares of common stock (or securities convertible into or
exercisable for additional shares of common stock) at a price below $.08 per
share. “Full ratchet” antidilution protection completely protects an investor’s
investment from subsequent price erosion until the occurrence of a liquidity
event. The anti-dilution protection will not apply, however, to issuances of
stock and options to our employees, directors, consultants and advisors pursuant
to any equity compensation plan approved by our stockholders.
The
Series F Preferred Stock is entitled to participate on an “as converted” basis
in all dividends or distributions declared or paid on our common stock. In the
event of any liquidation, dissolution or winding up of our company, the holders
of the Series F Preferred Stock will be entitled to be paid an amount equal to
$.08 per share of Series F Preferred Stock, plus any declared but unpaid
dividends, prior to the payment of any amounts to the holders of our Series E
Convertible Preferred Stock or common stock by reason of their ownership of such
stock.
-9-
IMPLANT
SCIENCES CORPORATION
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS
The
holders of the Series F Preferred Stock have no voting rights except as required
by applicable law. However, without the consent of the holders of a majority of
the Series F Preferred Stock, we may not (i) amend, alter or repeal any
provision of our Amended and Restated Articles of Organization or By-laws in a
manner that adversely affects the powers, preferences or rights of the Series F
Preferred Stock; (ii) authorize or issue any equity securities (or any equity or
debt securities convertible into equity securities) ranking prior and superior
to the Series F Preferred Stock with respect to dividends, distributions,
redemption rights or rights upon liquidation, dissolution or winding up; or
(iii) consummate any capital reorganization or reclassification of any of our
equity securities (or debt securities convertible into equity securities) into
equity securities ranking prior and superior to the Series F Preferred Stock
with respect to dividends, distributions, redemption rights or rights upon
liquidation, dissolution or winding up.
On August
5, 2009, we entered into a second amendment to the December 10, 2008 note and
warrant purchase agreement with DMRJ, pursuant to which we issued DMRJ a bridge
note in the principal amount of $700,000. The note bore interest at
the rate of 25% per annum. The outstanding principal balance and all interest
due under this bridge note was paid on September 4, 2009.
On
September 4, 2009, we entered into an additional credit agreement with DMRJ,
pursuant to which DMRJ provided us with a revolving line of credit in the
maximum principal amount of $3,000,000. In connection with the credit agreement,
we issued a promissory note to DMRJ evidencing our obligations under the credit
facility. Each of our subsidiaries guaranteed our obligations under the credit
facility. Our obligations and our subsidiaries’ obligations are secured by
grants of first priority security interests in all of our respective assets. In
addition, we agreed to cause all of our receivables and collections to be
deposited in a bank deposit account pledged to DMRJ pursuant to a blocked
account agreement. All funds deposited in the blocked collections account will
be applied towards the repayment of our obligations to DMRJ under the note.
Until the note and all of our obligations thereunder have been paid and
satisfied in full, we will have no right to access or make withdrawals from the
blocked account without DMRJ’s consent.
The note,
which has been amended, as described below, originally bore interest at the rate
of 25% per annum. Interest under the note is due on the first day of each
calendar month. The principal balance of the note, together with all outstanding
interest and all other amounts owed under the note, was originally due and
payable on December 10, 2009. We may prepay all or any portion of the principal
amount of the note, without penalty or premium, after prior notice to DMRJ.
Subject to applicable cure periods, amounts due under the note are subject to
acceleration upon certain events of default, including: (i) any failure to pay
when due any amount owed under the note; (ii) any failure to observe or perform
any other condition, covenant or agreement contained in the note or certain
conditions, covenants or agreements contained in the credit agreement; (iii)
certain suspensions of the listing or trading of our common stock; (iv) a
determination that any misrepresentation made by us to DMRJ in the credit
agreement or in any of the agreements delivered to DMRJ in connection with the
credit agreement were false or incorrect in any material respect when made; (v)
certain defaults under agreements related to any of our other indebtedness; (vi)
the institution of certain bankruptcy and insolvency proceedings by or against
us; (vii) the entry of certain monetary judgments against us that are not
dismissed or discharged within a period of 20 days; (viii) certain cessations of
our business in the ordinary course; (ix) the seizure of any material portion of
our assets by any governmental authority; and (x) our indictment for any
criminal activity.
In lieu
of paying DMRJ any commitment fees, closing fees or other fees in connection
with the credit agreement, we agreed to pay DMRJ an additional amount equal to
50% of or aggregate net profits, as defined, generated between the closing date
through the termination of the credit facility. Such payments will be due and
payable as earned upon (i) each request for an advance under the note, and (ii)
the termination of the credit facility. For the period September 4,
2009 through December 31, 2009, we experienced a net loss and no such payments
were due or payable to DMRJ as of December 31, 2009.
-10-
IMPLANT
SCIENCES CORPORATION
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS
Upon the
closing of the credit facility, we requested and were granted an initial advance
of approximately $1,633,000, of which we used approximately $715,000 to repay
all of our outstanding indebtedness to DMRJ pursuant to the bridge note issued
to DMRJ on August 5, 2009, and approximately $548,000 to retire certain
obligations owed to other parties. We used the balance of the initial advance
for working capital and ordinary course general corporate purposes.
On
December 20, 2009, we received written notice from DMRJ, stating that we were in
default of our obligations under each of the promissory notes described above.
On December 10, 2009, we failed to pay an aggregate of $7,505,678 in principal,
together with approximately $149,292 of interest, due on such date to DMRJ upon
the maturity of those notes.
As a
result of these defaults, effective December 11, 2009, (i) the interest rate
that we are obligated to pay to DMRJ under the promissory note issued in March
2009 automatically increased from 11% per annum to 2.5% per month (or the
maximum applicable legal interest rate, if less); (ii) the interest rate that we
are obligated to pay to DMRJ under the promissory note issued in July 2009
automatically increased from 2.5% per month to 3.0% per month (or the maximum
applicable legal interest rate, if less); and (iii) the interest rate that we
are obligated to pay to DMRJ under the promissory note issued in September 2009
increased from 25% per annum to 30% per annum (or the maximum applicable legal
interest rate, if less). All such default interest is payable upon demand by
DMRJ.
On
December 31, 2009, we received written notice from DMRJ, withdrawing its
December 20, 2009 default notice. Also on December 31, 2009, DMRJ
elected to convert $120,000 of the principal amount owed by us under one of the
promissory notes into 1,500,000 shares of our common stock, at an adjusted
conversion price of $.08 per share. DMRJ has subsequently converted additional
portions of our indebtedness on similar terms. Under the promissory notes and
related agreements, however, DMRJ may not convert any portion of the notes if
the number of shares of common stock to be issued pursuant to such conversion,
when aggregated with all other shares of common stock owned by DMRJ at such
time, would result in DMRJ beneficially owning in excess of 4.99% of the then
issued and outstanding shares of common stock. DMRJ may waive such limitation by
providing us with 61 days’ prior written notice.
As of
December 31, 2009, our obligations to DMRJ under the amended and restated senior
secured promissory note, the second senior secured promissory note and under the
credit facility approximated $4,480,000, $1,000,000 and $1,819,000,
respectively. Further, as of December 31, 2009, our obligation to
DMRJ for accrued interest under the amended senior secured promissory notes and
under the credit facility approximated $282,000. All such amounts were due and
payable on December 31, 2009.
On
January 12, 2010, we entered into an omnibus waiver and first amendment to
credit agreement and third amendment to note and warrant purchase agreement with
DMRJ pursuant to which: (i) our line of credit under the September 2009 credit
agreement was increased from $3,000,000 to $5,000,000; (ii) the maturity of all
of our indebtedness to DMRJ, including indebtedness under (a) the March 2009
amended and restated promissory note, (b) the July 2009 promissory note and (c)
the September 2009 revolving promissory note, was extended from December 10,
2009 to June 10, 2010; (iii) DMRJ waived all existing defaults under all of
these promissory notes and all related credit agreements through the new
maturity date of June 10, 2010; (iv) the interest rate payable on our
obligations under each of the promissory notes was reduced to 15% per annum; (v)
all arrangements pursuant to which we were to share with DMRJ any profits
resulting from certain transactions was removed from the credit documents; (vi)
we agreed to certain limitations on equity financings without DMRJ’s prior
consent; and (vii) we agreed that we will not prepay more than $3,600,000 of the
$5,600,000 of indebtedness owed to DMRJ under the March 2009 amended and
restated promissory note without DMRJ’s prior consent.
The
failure to refinance or otherwise negotiate extensions of our obligations to
DMRJ would have a material adverse impact on our liquidity and financial
condition and could force us to curtail or discontinue operations entirely and/or file for
protection under bankruptcy laws.
-11-
IMPLANT
SCIENCES CORPORATION
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS
We are
currently expending significant resources to develop the next generation of our
current products and to develop new products. Although we continue to
fund as much research and development as possible through government grants and
contracts in accordance with the provisions of the respective grant awards, we
will require additional funding in order to continue the advancement of the
commercial development and manufacturing of the explosives detection
system. We will attempt to obtain such financing by: (i) government
grants, (ii) private financing, or (iii) strategic
partnerships. However, there can be no assurance that we will be
successful in our attempts to raise such additional financing.
We
require substantial funds for further research and development, regulatory
approvals, and the marketing of our explosives detection
products. Our capital requirements depend on numerous factors,
including but not limited to the progress of our research and development
programs; the cost of filing, prosecuting, defending and enforcing any
intellectual property rights; competing technological and market developments;
changes in our development of commercialization activities and arrangements; the
hiring of additional personnel, and acquiring capital equipment.
Under our
agreements with Laurus Master Fund, Ltd. we were required to redeem our Series D
Cumulative Redeemable Convertible Preferred Stock on a monthly basis, with the
final redemption payment to be made in September 2008. We received a
waiver of the monthly redemption payments for the period December 2006 through
August 2007 and, in September 2007, we resumed making monthly
redemptions. In September, 2008, Laurus agreed to extend the final
redemption date to October 24, 2008 in exchange for a redemption payment of
$250,000, including $22,000 of accrued dividends. We did not meet our
redemption obligation on October 24, 2008 and, on November 4, 2008, we amended
our agreements with Laurus, effective as of October 31, 2008, to provide that
the amount necessary to redeem in full the Series D Preferred Stock would be
increased to $2,461,000, together with accrued and unpaid
dividends. Under these amendments, we agreed to make monthly
redemption payments through a new final redemption date of April 10,
2009. We redeemed $268,000 of the $518,000 of Series D Preferred
Stock required to be redeemed as of the October 31, 2008 redemption date by
agreeing to issue 929,535 shares of our common stock, and redeemed the balance
with a cash payment of $250,000. On December 10, 2008, we used
approximately $1,161,000 of the proceeds of the sale of the senior secured
convertible promissory note (see Note 13) to redeem in full all of our
outstanding Series D Preferred Stock. In May 2009, we issued 929,535
shares of our common stock to an affiliate of Laurus completing the redemption
of the Preferred Series D. As
of December 31, 2009 and 2008, our obligation to redeem the Series D Preferred
Stock amounted to $0.
2.
Interim Financial Statements and Basis of Presentation
The
accompanying condensed consolidated financial statements of we have been
prepared in accordance with U.S. generally accepted accounting principles (“U.S.
GAAP”). In the opinion of management, the accompanying condensed
consolidated financial statements include all adjustments (consisting only of
normal recurring adjustments), which we considers necessary for a fair
presentation of the financial position at such date and of the operating results
and cash flows for the periods presented. All intercompany balances
and transactions have been eliminated in consolidation. The results of
operations for the three and six months ended December 31, 2009 and cash flows
for the six months ended December 31, 2009 may not necessarily be indicative of
results that may be expected for any succeeding quarter or for the entire fiscal
year. The information contained in this Form 10-Q should be read in
conjunction with our audited financial statements, included in our Form 10-K, as
amended, as of and for the year ended June 30, 2009.
The
balance sheet at June 30, 2009 has been derived from our audited consolidated
financial statements at that date, but does not include all of the information
and footnotes required by U.S. GAAP for complete financial
statements.
The
accompanying condensed consolidated financial statements include our operations
in Massachusetts and California.
As a
result of our decision to dispose of Core, the operating results of Core are
presented in the accompanying condensed consolidated statements of operations as
discontinued operations for the six months ended December 31, 2008.
-12-
IMPLANT
SCIENCES CORPORATION
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS
As a
result of our decision to dispose of the medical business unit, the assets and
liabilities of the medical business unit are presented in the accompanying
condensed consolidated balance sheet as assets and liabilities held for sale as
of December 31, 2009 and June 30, 2009, and the operating results of the medical
business unit are presented in the accompanying condensed consolidated
statements of operations as discontinued operations for the three and six months
ended December 31, 2009 and 2008.
Additionally,
the following notes to the condensed consolidated financial statements include
disclosures related to our continuing operations unless specifically identified
as disclosures related to discontinued operations.
Significant
accounting policies are described in Note 2 to the financial statements included
in Item 7 of our Form 10-K, as amended, as of June 30, 2009. The
preparation of financial statements in conformity with U.S. GAAP requires
management to make estimates and judgments, which are evaluated on an ongoing
basis, that affect the amounts reported in our condensed consolidated financial
statements and accompanying notes. Management bases our estimates on
historical experience and on various other assumptions that it believes are
reasonable under the circumstances, the results of which form the basis for
making judgments about the carrying values of assets and liabilities and the
amounts of revenues and expenses that are not readily apparent from other
sources. Actual results could differ from those estimates and
judgments. In particular, significant estimates and judgments include
those related to revenue recognition, allowance for doubtful accounts, useful
lives of property and equipment, inventory reserves, valuation for goodwill and
acquired intangible assets, and realization of amounts held in
escrow.
Certain
reclassifications were made to the financial statements for the three and six
months ended December 31, 2008 to conform to the presentation for the three and
six months ended December 31, 2009.
We have
evaluated subsequent events after the balance sheet date through the date of
filing of these financial statements with the SEC on February 21, 2010, for
appropriate accounting and disclosure.
3.
Fair Value Measurement
The three
level fair value hierarchy to classify the inputs used in measuring fair value
are as follows:
Level 1
inputs to the valuation methodology are based on quoted prices (unadjusted) in
active markets for identical assets or liabilities;
Level 2
inputs to the valuation methodology are based are inputs other than quoted
prices included within Level 1 that are observable for the asset or liability,
either directly or indirectly; and
Level 3
inputs to the valuation methodology are based on unobservable inputs that
reflect our own assumptions about the assumptions market participants would use
in pricing the asset or liability.
Financial
assets and liabilities are classified in their entirety based on the lowest
level of input that is significant to the fair value
measurement.
Our
financial instruments at December 31, 2009 include cash equivalents, restricted
cash, accounts receivable, note receivable, accounts payable and senior secured
convertible promissory note. The carrying amounts of cash and cash equivalents,
restricted cash, receivables and accounts payable are representative of their
respective fair values because of the short-term maturities or expected
settlement dates of these instruments. The fair value of debt, as included in
Note 13, is based on the fair value of similar instruments.
4. Restricted
Cash
As
of December 31, 2009 and June 30, 2009, we had restricted cash of
$537,000 and $664,000, respectively. and consisted of the
following:
December
31,
|
June
30,
|
|||||||
2009
|
2009
|
|||||||
Money
market account
|
$ | 439,000 | $ | 439,000 | ||||
Blocked
account deposit
|
98,000 | 225,000 | ||||||
$ | 537,000 | $ | 664,000 |
-13-
IMPLANT
SCIENCES CORPORATION
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS
The
restricted cash of $439,000 held in a money market account collateralizes our
performance under an irrevocable letter of credit issued on June 25, 2008, in
the amount of $418,000. The letter of credit provides performance
security equal to 10% of the contract amount for security product which shipped
in the first quarter of fiscal 2009.
Pursuant
to our agreement with DMRJ (See Note 13), we are required to maintain a balance
of at least $500,000 in a bank deposit account pledged to DMRJ pursuant to a
blocked account agreement. On December 16, 2008, we
deposited $500,000 into a bank account pursuant to the blocked account
agreement. On March 12, 2009, we entered into a letter agreement with
DMRJ, pursuant to which DMRJ consented to grant us access to $250,000 out of the
funds held in the blocked account for a period commencing on March 12, 2009
through, but not including, April 15, 2009 at which date we were required to
maintain a minimum balance of not less that $500,000 in the blocked
account. On June 24, 2009, DMRJ consented to grant us access to an
additional $25,000, which was redeposited into the account on July 8,
2009. On July 16, 2009, DMRJ consented to the reduction in the
minimum balance required to be maintained in the blocked account through
September 3, 2009, after which time we were required to maintain a minimum
balance of at least $500,000 in the blocked account. On December 14,
2009, DMRJ consented to grant us access to the remaining $250,000 on deposit in
the blocked account, of which $150,000 was applied against
our obligation to DMRJ under the line of credit. As of
December 31, 2009, DMRJ waived the
requirement to maintain a deposit balance of at least $500,000 in such account.
As of December 31, 2009, the balance in the blocked account was
$0.
On
September 4, 2009, we entered into an additional credit agreement with DMRJ. In
connection with the credit agreement, we agreed to cause all of our receivables
and collections to be deposited in a bank deposit account pledged to DMRJ
pursuant to a blocked account agreement. All funds deposited in the blocked
collections account will be applied towards the repayment of our obligations to
DMRJ under the note. Until the note and all of our obligations thereunder have
been paid and satisfied in full, we will have no right to access or make
withdrawals from the blocked account without DMRJ’s consent. As
of December 31, 2009, the balance in the blocked account was
$98,000.
5.
Stock Based Compensation
Our
condensed consolidated statements of operations for the three months ended
December 31, 2009 and 2008 include $36,000 and $33,000, respectively, of
compensation costs and no income tax benefit related to our stock-based
compensation arrangements for employee and non-employee director
awards. Our condensed consolidated statements of operations for the
six months ended December 31, 2009 and 2008 include $79,000 and $147,000,
respectively, of compensation costs and no income tax benefit related to our
stock-based compensation arrangements for employee and non-employee director
awards. As of December 31, 2009, the total amount of unrecognized stock-based
compensation expense was approximately $199,000, which will be recognized over a
weighted average period of 2.05 years.
As of
December 31, 2009, there were options outstanding to purchase 3,250,538 shares
of our common stock at exercise prices ranging from $0.08 to
$10.00.
6.
Related Party Transactions
The
former chairman of Ion Metrics, Inc., which we acquired in April 2008, serves as
a Managing Director of a merger and acquisition and management advisory firm
that we previously engaged to market our wholly-owned subsidiary, Core Systems,
and to assist with our efforts to acquire additional capital. During
the three and six months ended December 31, 2008, this advisory firm was paid
$159,000 and $188,000, respectively. As of December 31, 2009, our obligation to
the advisory firm was $0. Further, we have entered into a fixed asset lease
agreement with Ferran Scientific, Inc., a firm owned by the father of the former
Ion Metrics chairman.
Robert
Liscouski, a member of our Board of Directors, serves as the head of strategic
and business development programs at Secure Strategy Group, a homeland
security-focused banking and strategic advisory firm that has been retained by
us to assist with our efforts to acquire additional capital. During
the three and six months ended December 31, 2009, this advisory firm was paid
$45,000 and $108,000, respectively. As of December 31, 2009, our
obligation to the advisory firm was $7,000.
On June
4, 2009, Michael Turmelle, a member of our Board of Directors loaned $100,000 to
us (see Note 7).
-14-
IMPLANT
SCIENCES CORPORATION
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS
7. Notes
Payable
On June
4, 2009, Michael Turmelle, a member of our Board of Directors, loaned $100,000
to us. The loan bears interest at 10% and is
unsecured. The principal amount of the loan will be converted into
preferred stock or any other equity securities upon the next completed equity
financing. As of December 31, 2009 and June 30, 2009, our obligation under the
note for borrowed funds amounted to $100,000. As of December 31,
2009, our obligation to Mr. Turmelle for accrued interest approximated
$6,000.
8.
Goodwill, Other Intangibles and Long-Lived Assets
In April
10, 2008, we acquired all of the capital stock of Ion Metrics, Inc., located in
San Diego, California. The transaction was structured as a
reorganization of Ion Metrics with and into our newly formed, wholly-owned
subsidiary. The aggregate purchase price of Ion Metrics was
$3,309,000.
The
following table summarizes the purchase price allocation to the fair value of
the assets at the date of acquisition:
Accounts
receivable
|
$ | 7,000 | ||
Other
receivables
|
3,000 | |||
Prepaid
expenses
|
11,000 | |||
Property,
plant and equipment
|
83,000 | |||
Goodwill
|
3,136,000 | |||
Customer
relationships
|
69,000 | |||
$ | 3,309,000 |
The
acquisition of Ion Metrics resulted in goodwill of $3,136,000 and the
identification of $69,000 of intangible assets with finite
lives. Goodwill represents the excess of cost over the fair value of
tangible and identifiable assets of acquired companies. Goodwill and
intangible assets with indefinite lives are not amortized, but rather are
measured for impairment at least annually or whenever events indicate that there
may be an impairment. An impairment loss would be recognized if the
fair value of the long-lived assets is less than their carrying
value.
We have
selected June 30th of
each year as the date we perform our annual assessment to determine if goodwill
is impaired. We completed our annual assessment at June 30, 2009 and determined
there was no impairment of goodwill and no event indicating an impairment has
occurred subsequent to June 30, 2009. At December 31, 2009 and
June 30, 2009, we had goodwill of $3,136,000.
Intangible
assets with finite lives are valued according to the future cash flows they are
estimated to produce. These assigned values are amortized over the
period of time those cash flows are estimated to be produced. We
evaluate whether events or circumstances have occurred that indicate that the
estimated remaining useful life or the carrying value of these assets has been
impaired.
Our
intangible assets are being amortized over a period of twelve months, the
estimated useful lives of the assets, from the date of acquisition, April 10,
2008. Amortization expense for the three months ended December 31,
2009 and 2008 was $0 and $17,000, respectively. Amortization expense
for the six months ended December 31, 2009 and 2008 was $0 and $35,000,
respectively.
-15-
IMPLANT
SCIENCES CORPORATION
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
9.
Inventories
We value
our inventories at lower of cost or market. Cost is determined by the
first-in, first-out (FIFO) method, including material, labor and factory
overhead.
Inventories
consist of the following:
December
31,
|
June
30,
|
|||||||
2009
|
2009
|
|||||||
Raw
materials
|
$ | 204,000 | $ | 162,000 | ||||
Work
in progress
|
23,000 | 20,000 | ||||||
Finished
goods
|
14,000 | 379,000 | ||||||
Total
inventories
|
$ | 241,000 | $ | 561,000 |
10.
Property and Equipment
Property
and equipment consist of the following:
December
31,
|
June
30,
|
|||||||
2009
|
2009
|
|||||||
Machinery
and equipment
|
$ | 220,000 | $ | 221,000 | ||||
Computers
and software
|
353,000 | 353,000 | ||||||
Furniture
and fixtures
|
8,000 | 8,000 | ||||||
Leasehold
improvements
|
76,000 | 72,000 | ||||||
Equipment
under capital lease
|
61,000 | 61,000 | ||||||
718,000 | 715,000 | |||||||
Less: accumulated
depreciation and amortization
|
506,000 | 439,000 | ||||||
$ | 212,000 | $ | 276,000 |
For the
three months ended December 31, 2009 and 2008, depreciation expense was $33,000
and $56,000, respectively. For the six months ended December 31, 2009
and 2008, depreciation expense was $67,000 and $110,000,
respectively.
11.
Accrued Expenses
Accrued
expenses consist of the following:
December
31,
|
June
30,
|
|||||||
2009
|
2009
|
|||||||
Accrued
compensation and benefits
|
$ | 573,000 | $ | 731,000 | ||||
Accrued
taxes
|
493,000 | 479,000 | ||||||
Accrued
legal and accounting
|
45,000 | 257,000 | ||||||
Accrued
interest
|
288,000 | 9,000 | ||||||
Accrued
warranty costs
|
151,000 | 196,000 | ||||||
Other
accrued liabilities
|
246,000 | 296,000 | ||||||
$ | 1,796,000 | $ | 1,968,000 |
-16-
IMPLANT
SCIENCES CORPORATION
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS
12.
Earnings Per Share
Basic
earnings per share is computed by dividing net income (loss) by the weighted
average number of common shares outstanding during the
period. Diluted earnings per share are based upon the weighted
average number of common shares outstanding during the period plus additional
weighted average common equivalent shares outstanding during the
period. Common equivalent shares result from the assumed exercise of
outstanding stock options and warrants, the proceeds of which are then assumed
to have been used to repurchase outstanding common stock using the treasury
stock method. In addition, the numerator is adjusted for any changes
in income or loss that would result from the assumed conversion of potential
shares. As of December 31, 2009 and 2008, all potentially dilutive
shares would have been excluded from the earnings per share calculation, because
their effect would be antidilutive. Shares deemed to be antidilutive
include stock options and warrants.
13. Long-Term Debt and Credit
Arrangements
Med-Tec
Payment Obligation
In July
2003, we entered into an asset purchase agreement with Med-Tec Iowa, Inc., our
former exclusive distributor of prostate seeds, to purchase Med-Tec’s customer
lists and further to release each other from further obligations under an
earlier distribution agreement. The purchase price of $1,250,000,
which was payable in varying amounts over 28 months, with the final payment
payable on December 1, 2005, was recorded at the present value of the future
payment stream, using a rate of 10.24%, which equaled
$1,007,000. This amount was recorded as an intangible asset and was
amortized over our estimated useful life of 29 months. The
outstanding and past due principal balance as of December 31, 2009 and June 30,
2009 was approximately $55,000 and $56,000, respectively.
Revolving
Credit Facility and Term Note
In June
2005, we executed a revolving credit facility for $1,500,000 with Silicon
Valley-based Bridge Bank, N.A. On January 3, 2007, the revolving
credit facility was increased from $1,500,000 to $5,000,000. In June,
August, October and November 2008, we entered into a series of further
amendments, waivers and modifications to our credit agreements with Bridge Bank,
pursuant to which, in exchange for the payment by us of forbearance fees in the
amount of $90,000, the bank waived certain existing and anticipated defaults,
the bank reduced our credit line to $1,500,000 from $5,000,000, and the bank
extended the modified facility through December 10, 2008. On December
10, 2008, we used approximately $477,000 of the proceeds of the sale of the
senior secured convertible promissory note to DMRJ to repay all of the
indebtedness outstanding to the bank and the credit facility was
terminated. As of December 31, 2009 and June 30, 2009, our obligation
for borrowed funds under the credit facility amounted to $0.
Pursuant
to the original loan agreement with Bridge Bank, we issued a seven-year warrant
to purchase 18,939 shares of our common stock at a price of $2.64 per
share. The warrant, valued using the Black-Scholes model, was
recorded at the relative fair value of $28,000 and accreted to the term note
over the life of the note. As of December 31, 2009, approximately
$28,000 has been amortized. Pursuant to an amendment to the loan
agreement, we issued to the Bank a seven-year warrant to purchase up to 43,860
additional shares of our common stock at a price equal to $1.14 per
share. The warrant, valued using the Black-Scholes model, was
recorded at the relative fair value of $29,000 and was charged to interest
expense during the year ended June 30, 2008.
Senior
Secured Convertible Promissory Note and Revolving Credit Facility
On
December 10, 2008, we entered into a note and warrant purchase agreement with
DMRJ Group LLC, an accredited institutional investor, pursuant to which we
issued a senior secured convertible promissory note in the principal amount of
$5,600,000 and a warrant to purchase 1,000,000 shares of our common
stock. The note, which is collateralized by all of our assets,
originally bore interest at 11.0% per annum. The effective
interest rate on the note as of the date of issuance was approximately
23.4%. We prepaid interest in the amount of $616,000 upon the
issuance of the note. In lieu of paying any commitment fees, closing
fees or other fees in connection with the purchase agreement, we transferred our
entire interest in 1,500,000 share of the common stock of CorNova, Inc., a
privately-held development stage medical device company, to DMRJ. The
note, which has been amended and restated, as described below, was originally
convertible in whole or in part at the option of DMRJ into shares of our common
stock at a conversion price of $0.26 per share.
-17-
IMPLANT
SCIENCES CORPORATION
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS
We valued
the note upon issuance at its residual value of $4,356,000 based on the fair
values of the financial instruments issued in connection with this convertible
debt financing, including the warrant, the original issue discount and the fair
value of the CorNova common stock transferred to DMRJ. The amounts
recorded in the financial statements represents the amounts attributed to the
senior secured convertible debt of $5,600,000, net of $160,000 allocated to the
warrant, $616,000 of original issue discount and $468,000 representing the
estimated fair value of the CorNova common stock. The warrant was
valued using the Black-Scholes model with the following
assumptions: volatility 98.4%, risk-free interest rate of 2.29%,
expected life of five years and expected dividend yield of 0.00%. As
required under the terms of the note, we made a principal payment of $1,000,000
on December 24, 2008. The note required us to make a principal
payment in an amount equal to any funds released from the escrow created in
connection with the May 2007 sales of the assets of Accurel Systems
International, upon the release of such funds. DMRJ
waived that requirement in connection with the settlement of the Evans
litigation.
On March
12, 2009, we entered into a letter agreement with DMRJ pursuant to which we were
granted access to $250,000 of previously restricted cash out of funds held in a
blocked account. The effect of the letter agreement made $250,000
available to us until the close of business on April 14, 2009. In consideration
of the letter agreement, on March 12, 2009, we issued an amended and restated
senior secured convertible promissory note and amended and restated warrant to
DMRJ to purchase shares of common stock, which replaced the note and warrant
issued on December 10, 2008. The terms of the amended and restated
note and the amended and restated warrant are identical to the terms of the
original note and warrant, except that the amended instruments reduced the
initial conversion price of the original note from $0.26 to $0.18 and reduced
the initial exercise price of the original warrant from $0.26 to
$0.18.
The note
contains restrictions and financial covenants including: (i) restrictions
against declaring or paying dividends or making any distributions; against
creating, assuming or incurring any liens; against creating, assuming
or incurring any indebtedness; against merging or consolidating with any other
company, provided,
however, that a merger or consolidation is permitted if we are the
surviving entity; against the sale, assignment, transfer or lease of our assets,
other than in the ordinary course of business and excluding inventory and
certain asset sales expressly permitted by the note purchase agreement; against
making investments in any company, extending credit or loans, or purchasing
stock or other ownership interest of any company; and (ii) covenants that we
have authorized or reserved for the purpose of issuance, 150% of the aggregate
number of shares of our common stock issuable upon exercise of the
warrant; that we maintain a minimum cash balance of at least
$500,000; that the aggregate dollar amount of all accounts payable be
no more than 100 days past due; and that we maintain a current ratio, defined as
current assets divided by current liabilities, of no less than 0.60 to
1.00.
On March
12, 2009, we entered into a letter agreement with DMRJ pursuant to which we were
granted access to $250,000 of previously restricted cash out of funds held in a
blocked account. The effect of the letter agreement made $250,000
available to us until the close of business on April 14, 2009. In consideration
of the letter agreement, on March 12, 2009, we issued an amended and restated
senior secured convertible promissory note and amended and restated warrant to
DMRJ to purchase shares of common stock, which replaced the note and warrant
issued on December 10, 2008. The terms of the amended and restated
note and the amended and restated warrant are identical to the terms of the
original note and warrant, except that the amended instruments reduced the
initial conversion price of the original note from $0.26 to $0.18 and reduced
the initial exercise price of the original warrant from $0.26 to
$0.18.
On July
1, 2009, we entered into an amendment to the December 10, 2008 note and warrant
purchase agreement with DMRJ, pursuant to which we issued a senior secured
promissory note to DMRJ in the principal amount of $1,000,000.
-18-
IMPLANT
SCIENCES CORPORATION
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS
The note,
which has been amended, as described below, originally bore interest at the rate
of 2.5% per month. The principal balance of the note, together with all
outstanding interest and all other amounts owed under the note, was originally
due and payable on the earlier of (i) December 10, 2009 and (ii) the receipt by
us of net proceeds of at least $3,000,000 from the issuance of debt and/or
equity securities in one or more transactions. In addition, at our option, DMRJ
may require us to prepay such amounts upon (i) certain consolidations, mergers
and business combinations involving us; (ii) the sale or transfer of more than
50% of our assets, other than inventory sold in the ordinary course of business,
in one or more related or unrelated transactions; or (iii) the issuance by us,
in one or more related or unrelated transactions, of any equity securities or
securities convertible into equity securities (other than options granted to
employees and consultants pursuant to employee benefit plans approved by our
Board of Directors), which results in net cash proceeds to us of more than
$500,000; provided,
however, that DMRJ may not require us to prepay more than the net cash
proceeds of any transaction described in the preceding clause (iii) of this
sentence. We may prepay all or any portion of the principal amount of the note,
without penalty or premium, after prior notice to DMRJ.
The
amendment to the loan agreement provides that, in the event we have not obtained
net proceeds from the issuance of debt or equity securities upon terms and
conditions acceptable to DMRJ in its sole discretion of (i) $1,000,000 by July
24, 2009 and (ii) to the extent that we satisfied such requirements, an
additional $2,000,000 by August 21, 2009, we will immediately engage in a sale
process satisfactory to DMRJ in its sole discretion by implementing a
contingency plan which may be established by DMRJ, including, without
limitation, the engagement at our expense of a third party investment banker
acceptable to DMRJ in its sole discretion. We did not satisfy these
requirements and, in August 2009, we engaged Pickwick Capital Partners to market
our company for sale.
In
connection with the additional note issued on July 1, 2009, we also issued
871,763 shares of our Series F Convertible Preferred Stock to DMRJ, and agreed
that, if we were unable to obtain net proceeds of at least $3,000,000 from the
issuance of debt and/or equity securities by August 31, 2009, we would issue
774,900 additional shares of Series F Preferred Stock to DMRJ. DMRJ later
extended this deadline until October 1, 2009. We did not satisfy this
requirement and, on October 1, 2009, we issued the additional shares to DMRJ.
All of the 1,646,663
shares of Series F Preferred Stock held by DMRJ are convertible into 25%
of our common stock, calculated on a fully diluted basis. In addition, for so
long as the July 2009 note or the amended and restated senior secured
convertible promissory note issued to DMRJ in March 2009 remain outstanding, we
may not issue additional shares of common stock, or other securities convertible
into or exercisable for common stock, if such securities would increase the
number of shares of our common stock, calculated on a fully diluted basis, unless we simultaneously
issue to DMRJ that number of additional shares of Series F Preferred Stock which
is necessary to result in the number of shares of common stock into which all
Series F Preferred Stock held by DMRJ may be converted representing the same
percentage ownership of our common stock on a fully diluted basis after such
issuance as immediately prior thereto. We calculated the value of the
Series F Preferred Stock to be $378,000, which amount represents 25% of the fair
value of the Company on the date of issuance based on the market capitalization
as of that date.
After the
repayment in full of the promissory notes, described above, the number of shares
of common stock into which the Series F Preferred Stock is convertible will
remain subject to “full ratchet” antidilution protection in the event that we
issue additional shares of common stock (or securities convertible into or
exercisable for additional shares of common stock) at a price below $.08 per
share. “Full ratchet” antidilution protection completely protects an investor’s
investment from subsequent price erosion until the occurrence of a liquidity
event. The anti-dilution protection will not apply, however, to issuances of
stock and options to our employees, directors, consultants and advisors pursuant
to any equity compensation plan approved by our stockholders. The
Series F Preferred Stock is convertible into common stock based in a formula
whereby the original exercise price of $0.08 per share is divided by the then
fair value of our common stock on the date of conversion and multiplied by
tne. As of the issuance date of the Series F Preferred Stock this
calculation would have resulted in 16,466,630 shares of common
stock.
The
Series F Preferred Stock is entitled to participate on an “as converted” basis
in all dividends or distributions declared or paid on our common stock. In the
event of any liquidation, dissolution or winding up of our company, the holders
of the Series F Preferred Stock will be entitled to be paid an amount equal to
$.08 per share of Series F Preferred Stock, plus any declared but unpaid
dividends, prior to the payment of any amounts to the holders of our Series E
Convertible Preferred Stock or common stock by reason of their ownership of such
stock.
-19-
IMPLANT
SCIENCES CORPORATION
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS
The
holders of the Series F Preferred Stock have no voting rights except as required
by applicable law. However, without the consent of the holders of a majority of
the Series F Preferred Stock, we may not (i) amend, alter or repeal any
provision of our Amended and Restated Articles of Organization or By-laws in a
manner that adversely affects the powers, preferences or rights of the Series F
Preferred Stock; (ii) authorize or issue any equity securities (or any equity or
debt securities convertible into equity securities) ranking prior and superior
to the Series F Preferred Stock with respect to dividends, distributions,
redemption rights or rights upon liquidation, dissolution or winding up; or
(iii) consummate any capital reorganization or reclassification of any of our
equity securities (or debt securities convertible into equity securities) into
equity securities ranking prior and superior to the Series F Preferred Stock
with respect to dividends, distributions, redemption rights or rights upon
liquidation, dissolution or winding up.
On August
5, 2009, we entered into a second amendment to the December 10, 2008 note and
warrant purchase agreement with DMRJ, pursuant to which we issued DMRJ a bridge
note in the principal amount of $700,000. The note bore interest at
the rate of 25% per annum. The outstanding principal balance and all interest
due under this bridge note was paid on September 4, 2009.
On
September 4, 2009, we entered into an additional credit agreement with DMRJ,
pursuant to which DMRJ provided us with a revolving line of credit in the
maximum principal amount of $3,000,000. In connection with the credit agreement,
we issued a promissory note to DMRJ evidencing our obligations under the credit
facility. Each of our subsidiaries guaranteed our obligations under the credit
facility. Our obligations and our subsidiaries’ obligations are secured by
grants of first priority security interests in all of our respective assets. In
addition, we agreed to cause all of our receivables and collections to be
deposited in a bank deposit account pledged to DMRJ pursuant to a blocked
account agreement. All funds deposited in the blocked collections account will
be applied towards the repayment of our obligations to DMRJ under the note.
Until the note and all of our obligations thereunder have been paid and
satisfied in full, we will have no right to access or make withdrawals from the
blocked account without DMRJ’s consent.
The note,
which has been amended, as described below, originally bore interest at the rate
of 25% per annum. Interest under the note is due on the first day of each
calendar month. The principal balance of the note, together with all outstanding
interest and all other amounts owed under the note, was originally due and
payable on December 10, 2009. We may prepay all or any portion of the principal
amount of the note, without penalty or premium, after prior notice to DMRJ.
Subject to applicable cure periods, amounts due under the note are subject to
acceleration upon certain events of default, including: (i) any failure to pay
when due any amount owed under the note; (ii) any failure to observe or perform
any other condition, covenant or agreement contained in the note or certain
conditions, covenants or agreements contained in the credit agreement; (iii)
certain suspensions of the listing or trading of our common stock; (iv) a
determination that any misrepresentation made by us to DMRJ in the credit
agreement or in any of the agreements delivered to DMRJ in connection with the
credit agreement were false or incorrect in any material respect when made; (v)
certain defaults under agreements related to any of our other indebtedness; (vi)
the institution of certain bankruptcy and insolvency proceedings by or against
us; (vii) the entry of certain monetary judgments against us that are not
dismissed or discharged within a period of 20 days; (viii) certain cessations of
our business in the ordinary course; (ix) the seizure of any material portion of
our assets by any governmental authority; and (x) our indictment for any
criminal activity.
In lieu
of paying DMRJ any commitment fees, closing fees or other fees in connection
with the credit agreement, we agreed to pay DMRJ an additional amount equal to
50% of or aggregate net profits, as defined, generated between the closing date
through the termination of the credit facility. Such payments will be due and
payable as earned upon (i) each request for an advance under the note, and (ii)
the termination of the credit facility. For the period September 4,
2009 through December 31, 2009, we experienced a net loss and no such payments
were due or payable to DMRJ as of December 31, 2009.
Upon the
closing of the credit facility, we requested and were granted an initial advance
of approximately $1,633,000, of which we used approximately $715,000 to repay
all of our outstanding indebtedness to DMRJ pursuant to the bridge note issued
to DMRJ on August 5, 2009, and approximately $548,000 to retire certain
obligations owed to other parties. We used the balance of the initial advance
for working capital and ordinary course general corporate purposes.
-20-
IMPLANT
SCIENCES CORPORATION
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS
On
December 20, 2009, we received written notice from DMRJ, stating that we were in
default of our obligations under each of the promissory notes described above.
On December 10, 2009, we failed to pay an aggregate of $7,505,678 in principal,
together with approximately $149,292 of interest, due on such date to DMRJ upon
the maturity of those notes.
As a
result of these defaults, effective December 11, 2009, (i) the interest rate
that we are obligated to pay to DMRJ under the promissory note issued in March
2009 automatically increased from 11% per annum to 2.5% per month (or the
maximum applicable legal interest rate, if less); (ii) the interest rate that we
are obligated to pay to DMRJ under the promissory note issued in July 2009
automatically increased from 2.5% per month to 3.0% per month (or the maximum
applicable legal interest rate, if less); and (iii) the interest rate that we
are obligated to pay to DMRJ under the promissory note issued in September 2009
increased from 25% per annum to 30% per annum (or the maximum applicable legal
interest rate, if less). All such default interest is payable upon demand by
DMRJ.
On
December 31, 2009, we received written notice from DMRJ, withdrawing its
December 20, 2009 default notice. Also on December 31, 2009, DMRJ
elected to convert $120,000 of the principal amount owed by us under one of the
promissory notes into 1,500,000 shares of our common stock, at an adjusted
conversion price of $.08 per share. DMRJ has subsequently converted additional
portions of our indebtedness on similar terms. Under the promissory notes and
related agreements, however, DMRJ may not convert any portion of the notes if
the number of shares of common stock to be issued pursuant to such conversion,
when aggregated with all other shares of common stock owned by DMRJ at such
time, would result in DMRJ beneficially owning in excess of 4.99% of the then
issued and outstanding shares of common stock. DMRJ may waive such limitation by
providing us with 61 days’ prior written notice.
As of
December 31, 2009, our obligations to DMRJ under the amended and restated senior
secured promissory note, the second senior secured promissory note and under the
credit facility approximated $4,480,000, $1,000,000 and $1,819,000,
respectively. Further, as of December 31, 2009, our obligation to
DMRJ for accrued interest under the amended senior secured promissory notes and
under the credit facility approximated $282,000. All such amounts were due and
payable on December 31, 2009.
On
January 12, 2010, we entered into an omnibus waiver and first amendment to
credit agreement and third amendment to note and warrant purchase agreement with
DMRJ pursuant to which: (i) our line of credit under the September 2009 credit
agreement was increased from $3,000,000 to $5,000,000; (ii) the maturity of all
of our indebtedness to DMRJ, including indebtedness under (a) the March 2009
amended and restated promissory note, (b) the July 2009 promissory note and (c)
the September 2009 revolving promissory note , was extended from December 10,
2009 to June 10, 2010; (iii) DMRJ waived all existing defaults under all of
these notes and all related credit agreements through the new maturity date of
June 10, 2010; (iv) the interest rate payable on our obligations under each of
these promissory notes was reduced to 15% per annum; (v) all arrangements
pursuant to which we were to share with DMRJ any profits resulting from certain
transactions was removed from the credit documents; (vi) we agreed to certain
limitations on equity financings without DMRJ’s prior consent; and (vii) we
agreed that we will not prepay more than $3,600,000 of the $5,600,000 of
indebtedness owed to DMRJ under the March 2009 amended and restated promissory
note without DMRJ’s prior consent.
The
failure to refinance or otherwise negotiate extensions of our obligations to
DMRJ would have a material adverse impact on our liquidity and financial
condition and could force us to curtail or discontinue operations entirely and/or file for
protection under bankruptcy laws.
14.
Series D Convertible Preferred Stock
In
September 2005, we issued 500,000 shares of Series D Convertible Preferred
Stock, having a stated value of $10 per share, pursuant to a securities purchase
agreement with Laurus Master Fund, Ltd. for gross cash proceeds of
$5,000,000. The Series D Preferred Stock had a dividend equal to the
prime rate plus one percent and originally provided for redemption over a
thirty-six month period, pursuant to an amortization schedule.
-21-
IMPLANT
SCIENCES CORPORATION
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS
We valued
the Series D Preferred Stock at issuance at its residual value of $2,700,000
based on the fair values of the financial instruments issued in connection with
this preferred stock financing, including certain warrants, the embedded
derivative instruments and offering costs. The amounts recorded in
the financial statements represent the amounts attributed to the sale of the
Series D Preferred Stock, the amount allocated to warrants, the value attributed
to the embedded derivatives and issuance costs. We accreted these
discounts on the carrying value of the Series D Preferred Stock to its
redemption value the actual conversion date. The accretion was
recorded as a preferred dividend in the period of accretion. For the
three months ended December 31, 2009 and 2008, $0 and $155,000, respectively,
was amortized.
We
received a waiver of the monthly redemption payments for the period December
2006 through August 2007 and resumed making monthly redemptions in September
2007. In September, 2008, Laurus agreed to extend the final redemption date to
October 24, 2008 in exchange for a redemption payment of $250,000, including
$22,000 of accrued dividends. We did not meet our redemption
obligation on October 24, 2008 and, on November 4, 2008, we amended our
agreements with Laurus, effective as of October 31, 2008, to provide that the
amount necessary to redeem in full the Series D Preferred Stock would be
increased to $2,461,000, together with accrued and unpaid
dividends. The agreed upon redemption amount for the Series D
Preferred Stock included a penalty of approximately $568,000, which amount was
charged to interest expense in the fiscal year ended June 30, 2009.
On
October 31, 2009, we redeemed $268,000 of the $518,000 of Series D Preferred
Stock required to be redeemed on that date by agreeing to issue 929,535 shares
of our common stock to an affiliate of Laurus, and redeemed the balance due on
that date with a cash payment of $250,000. The shares were valued at
$0.28829 per share, which was equal to the volume-weighted average price of our
common stock as reported by Bloomberg, L.P. for the 15-day period immediately
preceding the date of the amendment.
On
November 25, 2008 we redeemed an additional $800,000 of the Series D Preferred
Stock, using proceeds from the sale of the assets of Core Systems. On
December 10, 2008, we used approximately $1,161,000 of the proceeds from the
sale of senior secured convertible promissory note to DMRJ to repay all of the
indebtedness outstanding to the Laurus, excluding the Series D Preferred Stock
redemption which was redeemed, in May 2009, when we issued 929,535 shares of our
common stock to an affiliate of Laurus completing the redemption of the Series D
Preferred Stock.
As
December 31, 2009 and June 30, 2009, the outstanding balance on the Series D
Preferred Stock was $0.
15.
Series E Convertible Preferred Stock
In March
27, 2009, we announced the settlement of our litigation and the mutual release
by us and Evans Analytical Group, LLC of all claims related to the sale of
Accurel. In settling this litigation, we issued 1,000,000 shares of
Series E Convertible Preferred Stock, having an aggregate liquidation preference
of $5,000,000. The preferred stock, however, will be subject to
cancellation, without consideration and without liability to us, under certain
conditions related to our continued cooperation in the pursuit (as controlled
and funded by Evans and its counsel) of certain claims against a former officer
of ours and Accurel related to the sale of Accurel to Evans, including the
outcome of such litigation. The stock is convertible into common
stock under various scenarios, including by either party after the ninth
anniversary of the settlement agreement, and under certain other
circumstances. The preferred stock will be entitled to participate on
an “as converted” basis in all dividends or distributions declared or paid on
our common stock and holders of the preferred stock will have no voting rights
except as required by applicable law.
16.
Series F Convertible Preferred Stock
In
connection with the July 1, 2009 amendment to the December 10, 2008 note and
warrant purchase agreement with DMRJ, pursuant to which we issued a senior
secured promissory note to DMRJ in the principal amount of $1,000,000, we issued
871,763 shares of our Series F Convertible Preferred Stock. The
871,763 shares of Series F Preferred Stock issued to DMRJ are convertible at the
option of DMRJ into 15% of our common stock, calculated on a fully diluted
basis.
-22-
IMPLANT
SCIENCES CORPORATION
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS
Because
we did not obtain net proceeds of at least $3,000,000 from the issuance of debt
and/or equity securities by August 31, 2009 (later extended by DMRJ to October
1, 2009), we were required to issue to DMRJ 774,900 additional shares of Series
F Preferred Stock. Upon the issuance of those shares, all of the Series F
Preferred Stock then held by DMRJ was convertible into 25% of our common stock,
calculated on a fully diluted basis. In addition, for so long as the promissory
note issued in July 2009 or the amended and restated promissory note issued in
March 2000 remain outstanding, we may not issue additional shares of common
stock, or other securities convertible into or exercisable for common stock, if
such securities would increase the number of shares of our common stock,
calculated on a fully diluted basis, unless we simultaneously issues to DMRJ
that number of additional shares of Series F Preferred Stock which is necessary
to result in the number of shares of common stock into which all Series F
Preferred Stock held by DMRJ may be converted representing the same percentage
ownership of our common stock on a fully diluted basis after such issuance as
immediately prior thereto.
We have
recorded the fair value of the Series F Preferred Stock of approximately
$378,000 against the senior secured convertible promissory note, which is
accreted to the note over the life of the note. The fair value of the
Series F Preferred Stock is equal to the fair value of the company, defined as
the product of our common shares outstanding times the closing price of our
common stock on the date of issuance, multiplied by 25%. For the three and six
months ended December 31, 2009, $165,000 and $378,000, respectively, was
accreted to the note and is recorded as interest expense on our statement of
operations.
17. Stockholders' Equity
Common
Stock Options and Warrants
In
connection with various financing agreements and services provided by
consultants, we have issued warrants to purchase shares of our common
stock. The fair value of warrants issued is determined using the
Black-Scholes option pricing model. In December 2008, in conjunction
with the issuance of the senior secured convertible note to DMRJ, we issued
five-year warrants to purchase 1,000,000 shares of common stock at an initial
exercise price of $0.26 per share. The warrant is exercisable between
December 10, 2008 and December 10, 2013. In consideration of DMRJ’s
execution of the letter agreement on March 12, 2009, we issued an amended and
restated warrant to purchase shares of common stock, to reduce the initial
exercise price of the warrant from $0.26 to $0.18, and recorded the fair value
of this warrant of approximately $160,000 against the senior secured convertible
promissory note, which is accreted to the note over the life of the note. As a
result of the issuance of the Series F Preferred Stock, the exercise price of
the warrant was automatically reduced under its antidilution provisions to
$0.08. In the three and six months ended December 31, 2009, we
recorded an additional charge of $10,000 to interest expense, representing the
fair value of the incremental consideration resulting from the reduction in the
exercise price of the warrant.
As of
December 31, 2009, there were warrants outstanding to purchase 3,041,217 shares
of our common stock at exercise prices ranging from $0.08 to $12.45 expiring at
various dates between January 11, 2010 and June 27, 2015.
We did
not issue shares of common stock during the six months ended December 31, 2009
and 2008, as a result of the exercise of options by our employees and
consultants.
Employee
Stock Purchase Plan
During
the six months ended December 31, 2008, we issued 31,147 shares of our common
stock to our employees pursuant to the terms of the 2006 Employee Stock Purchase
Plan. There were no shares issued pursuant to the terms of this plan
during the six months ended December 31, 2009.
Treasury
Stock and Other Transactions
In June
2004, our Board of Directors authorized us to repurchase up to 300,000 shares of
our common stock, from time to time in the open market, privately negotiated
transactions, block transactions or at time and prices deemed appropriate by
management. As of December 31, 2009 and June 30, 2009, 10,545 shares
were held in treasury at cost. During each of the six months ended
December 31, 2009 and 2008 , we repurchased no shares of our common
stock. As of December 31, 2009, the maximum number of shares
authorized to be repurchased were 289,455.
-23-
IMPLANT
SCIENCES CORPORATION
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS
18.
Income Taxes
We use
the liability method to accounting for income taxes. Under this method, deferred
taxes are determined based on the difference between the financial statement and
tax bases of assets and liabilities using enacted tax rates in effect in the
years in which the differences are expected to reverse. Deferred tax
assets are recognized and measured based on the likelihood of realization of the
related tax benefit in the future.
For the
three and six months ended December 31, 2009 and 2008, we provided for no taxes
as we have significant net loss carryforwards.
19.
Investment in CorNova
On
December 10, 2008, we transferred our entire interest in 1,500,000 shares of the
common stock of CorNova, Inc. to DMRJ Group LLC in lieu of commitment fees,
closing fees and other transaction related fees in connection with our issuance
of the senior secured convertible promissory note (See Note 13). As a
result, $123,000 representing unrealized losses of our share of CardioTech stock
owned by CorNova which had been recorded as a separate component of equity in
other accumulated comprehensive loss were realized and recorded to other expense
in the statement of operations in the year ended June 30, 2009. In
addition, we recorded a $468,000 gain on the transfer of our investment in the
CorNova common stock to other income in the statement of operations in the year
ended June 30, 2009. Prior to the transfer of the CorNova shares, our
ownership interest in CorNova was 15%. As of December 31, 2009 and
June 30, 2009, our investment in CorNova was $0.
We had
historically accounted for our investment in CorNova, an unconsolidated
subsidiary, under the equity method, due in part, to the significant influence
we had over CorNova resulting from Dr. Anthony J. Armini serving on CorNova’s
Board of Directors. Dr. Armini served as our President and Chief
Executive Officer. As a result of Dr. Armini’s resignation from these
positions in September 2007, the equity method was no longer appropriate and the
cost method was used.
20.
Commitments and Contingencies
We lease
manufacturing, research and office space in Wilmington, MA, the lease of which
expires on December 31, 2009. Under the terms of the lease, we are
responsible for our proportionate share of real estate taxes and operating
expenses relating to this facility. We lease a facility in Sunnyvale,
CA, which lease expires in September 2010. Effective with the sale of
the assets of Accurel Systems on May 1, 2007, we executed a sublease agreement
for one of our California facilities. As a result of the Ion Metrics
acquisition, we assumed a lease for research and office space in San Diego, CA,
which lease was renewed and expires on January 31, 2012. Total rent
expense, including assessments for maintenance and real estate taxes for the six
months ended December 31, 2009 and 2008, for both continuing and discontinued
operations was $264,000 and $718,000, respectively.
In
conjunction with the acquisition of Accurel, in March 2005, we recorded a lease
liability of $829,000. This liability reflected management’s estimate
of the excess of payments required under the Accurel facility lease, at the date
of acquisition, versus the fair market value of lease payments that would have
been required, had the lease been negotiated under current market
conditions. Subsequently, as a result of the sale of Accurel, we have
recorded an additional liability of $487,000 representing that portion of the
lease in excess of the sublease arrangement between Accurel Systems and Evans
Analytical Group, LLC.
-24-
IMPLANT
SCIENCES CORPORATION
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS
In April
2009, Silicon Valley CA-I, LLC, the lessor of such property to Accurel, filed
suit against Accurel and Evans in the Superior Court of the State of California,
County of Santa Clara, alleging nonpayment of rent. On June 24, 2009, Accurel
entered into a release and settlement agreement with the lessor, under the terms
of which Accurel was required to pay $224,840, representing the amounts that are
past due under the lease, plus monthly rents owing under the lease, less the
payment that Evans is required to make under the terms of the settlement
agreement. Accurel was required to pay such amount on or before
September 4, 2009. On September 4, 2009, Accurel remitted the
settlement payment. In accordance with the release and settlement
agreement, provided that Accurel and Evans have complied with the terms of the
lease and payment in accordance with the agreement, the lessor has agreed to
dismiss the suit on or before September 14, 2009 and Accurel will have no
further obligations or liabilities to the lessor. On October 28,
2009, the request for dismissal was entered with the Superior Court of the State
of California, County of Santa Clara. As a result of the dismissal of
litigation, we recorded a lease termination benefit of $384,000 related to
Accurel’s lease obligations in the three and six months ended December 31, 2009.
The balance of the lease liability on December 31, 2009 was $0.
In April
2007, in conjunction with our plans to conduct research, development and minor
manufacturing work in New Mexico, we executed an operating lease which was
initially to expire on May 1, 2010. The lease allowed for early
termination, which we elected in February 2008. As a result of the
early termination, we are responsible for reimbursing the landlord for certain
leasehold improvements over a 24-month period. As of December 31,
2009, the balance due is approximately $27,000 and is included in current
liabilities.
21.
Financial Information By Segment
Operating
segments are defined as components of an enterprise about which separate
financial information is available that is regularly evaluated by the chief
operating decision maker or decision making group, in determining how to
allocate resources and in accessing performance. Our chief operating
decision making group is composed of the chief executive officer and members of
senior management. Based on qualitative and quantitative criteria, we
have determined that we operate within one reportable segment, which is the
Security Products Segment.
22. Discontinued Operations
Core
Systems
The
accompanying condensed consolidated balance sheets as of June 30, 2009 and
statements of operations for the three and six months ended December 31, 2008 of
C Acquisition Corp., our former wholly-owned semiconductor subsidiary, which has
operated under the name Core Systems, are presented as discontinued
operations. Our Board of Directors approved a plan to sell Core
Systems in February 2008. We have (i) eliminated Core Systems’
financial results from our ongoing operations, (ii) determined that Core
Systems, which operated as a separate subsidiary, was a separate component of
our aggregated business as, historically, management reviewed separately the
Core Systems financial results and cash flows apart from our ongoing continuing
operations, and (iii) determined that it will have no further continuing
involvement in the operations of Core Systems or cash flows from Core Systems
after the sale.
Condensed
results of operations relating to Core Systems for the three and six months
ended December 31, 2008 are as follows:
Three
Months Ended
|
Six
Months Ended
|
|||||||
December
31,
|
December
31,
|
|||||||
2008
|
2008
|
|||||||
Revenues
|
$ | 782,000 | $ | 2,288,000 | ||||
Gross
profit
|
176,000 | 471,000 | ||||||
Operating
income
|
8,000 | 25,000 | ||||||
Non-operating
expense
|
22,000 | 21,000 | ||||||
Income
from discontinued operations
|
$ | 30,000 | $ | 46,000 |
-25-
IMPLANT
SCIENCES CORPORATION
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS
The
calculation of the gain of sale of Core Systems assets, recorded in the
statement of operations for the three and six months ended December 31, 2008 is
as follows:
Three
Months Ended
|
Six
Months Ended
|
|||||||
December
31,
|
December
31,
|
|||||||
2008
|
2008
|
|||||||
Proceeds
|
||||||||
Cash
|
$ | 1,375,000 | $ | 1,375,000 | ||||
Note
receivable
|
1,625,000 | 1,625,000 | ||||||
3,000,000 | 3,000,000 | |||||||
Direct
costs
|
||||||||
Broker
and advisory fees
|
229,000 | 229,000 | ||||||
Legal
fees
|
28,000 | 28,000 | ||||||
Other
|
38,000 | 38,000 | ||||||
295,000 | 295,000 | |||||||
Net
proceeds
|
2,705,000 | 2,705,000 | ||||||
Net
book value of assets sold
|
3,344,000 | 3,344,000 | ||||||
Liabilities
assumed
|
(661,000 | ) | (661,000 | ) | ||||
2,683,000 | 2,683,000 | |||||||
Gain
on sale of assets
|
$ | 22,000 | $ | 22,000 |
Medical
Business Unit
The
accompanying condensed consolidated balance sheets and statements of operations
present the results of the Medical Business Unit as discontinued
operations.
Condensed
results of operations relating to the Medical Business Unit for the three and
six months ended December 31, 2009 and 2008 are as follows:
Three
Months Ended
|
Six
Months Ended
|
|||||||||||||||
December
31,
|
December
31,
|
|||||||||||||||
2009
|
2008
|
2009
|
2008
|
|||||||||||||
Revenues
|
$ | - | $ | 200,000 | $ | - | $ | 557,000 | ||||||||
Gross
profit
|
- | (94,000 | ) | (20,000 | ) | (51,000 | ) | |||||||||
Operating
(loss) income
|
- | (94,000 | ) | (20,000 | ) | (51,000 | ) | |||||||||
Gain
on sale of assets
|
- | 93,000 | - | 1,024,000 | ||||||||||||
(Loss)
income from discontinued operations
|
$ | - | $ | (1,000 | ) | $ | (20,000 | ) | $ | 973,000 |
The
calculation of the gain on sale of medical business unit assets, recorded in the
statement of operations for the three and six months ended December 31, 2008 is
as follows:
Three
Months Ended
|
Six
Months Ended
|
|||||||
December
31,
|
December
31,
|
|||||||
2008
|
2008
|
|||||||
Proceeds
|
$ | 445,000 | $ | 1,590,000 | ||||
Direct
costs
|
13,000 | 33,000 | ||||||
Net
proceeds
|
432,000 | 1,557,000 | ||||||
Net
book value of assets sold
|
339,000 | 533,000 | ||||||
Gain
on sale of assets
|
$ | 93,000 | $ | 1,024,000 |
-26-
IMPLANT
SCIENCES CORPORATION
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS
The
assets and liabilities of the Medical Business Unit as of December 31, 2009 and
June 30, 2009 are as follows:
December
31,
|
June
30,
|
|||||||
2009
|
2009
|
|||||||
Assets
of Discontinued Operations
|
||||||||
Current
assets of discontinued operations:
|
||||||||
Accounts
receivable-trade, net
|
$ | - | $ | 51,000 | ||||
Inventories
|
103,000 | 118,000 | ||||||
Total
assets of discontinued operations
|
$ | 103,000 | $ | 169,000 | ||||
Liabilities
of Discontinued Operations
|
||||||||
Current
liabilities of discontinued operations:
|
||||||||
Accounts
payable
|
$ | 63,000 | $ | 96,000 | ||||
Accrued
expenses
|
- | 11,000 | ||||||
Total
liabilities of discontinued operations
|
$ | 63,000 | $ | 107,000 |
23.
Legal Proceedings
From time
to time, we are subject to various claims, legal proceedings and investigations
covering a wide range of matters that arise in the ordinary course of our
business activities. Each of these matters is subject to various
uncertainties.
Evans
Analytical Group LLC
In
conjunction with the May 2007 sale of our Accurel business to Evans Analytical,
Accurel entered into a sublease of its facility to Evans. In April
2009, Silicon Valley CA-I, LLC, the lessor of such property to Accurel, filed
suit against Accurel and Evans in the Superior Court of the State of California,
County of Santa Clara, alleging nonpayment of rent. On June 24, 2009, Accurel
and Evans entered into a release and settlement agreement with the lessor, under
the terms of which Accurel was required to pay $224,840, representing the
amounts that are past due under the lease, plus monthly rents owing under the
lease, less the payment that Evans is required to make under the terms of the
settlement agreement. Accurel was required to pay such amount on or
before September 4, 2009. On September 4, 2009, Accurel remitted the settlement
payment. In accordance with the release and settlement agreement,
provided that Accurel and Evans have complied with the terms of the lease and
payment in accordance with the agreement, the lessor has agreed to dismiss the
suit on or before September 14, 2009, and Accurel will have no further
obligations or liabilities to the lessor. On October 28, 2009, the
request for dismissal was entered with the Superior Court of the State of
California, County of Santa Clara.
We may,
from time to time, be involved in other actual or potential proceedings that it
considers to be in the normal course of our business. We do not
believe that any of these proceedings will have a material adverse effect on our
business.
24.
Subsequent Events
On
January 12, 2010, we entered into an omnibus waiver and first amendment to
credit Agreement and third amendment to note and warrant purchase
agreement with DMRJ (see Note 1).
-27-
Item
2.
|
Management’s
Discussion and Analysis of Financial Condition and Results of
Operations
|
Cautionary
Note Regarding Forward-Looking Statements
This
Quarterly Report on Form 10-Q contains certain statements that are
“forward-looking” within the meaning of the Private Securities Litigation Reform
Act of 1995 (the “Litigation Reform Act”). These forward looking
statements and other information are based on our beliefs as well as assumptions
made by us using information currently available.
The words
“anticipate,” “believe,” “estimate,” “expect,” “intend,” “will,” “should” and
similar expressions, as they relate to us, are intended to identify
forward-looking statements. Such statements reflect our current views
with respect to future events, are subject to certain risks, uncertainties and
assumptions, and are not guaranties of future performance. Should one
or more of these risks or uncertainties materialize, or should underlying
assumptions prove incorrect, actual results may vary materially from those
described herein as anticipated, believed, estimated, expected, intended or
using other similar expressions.
In
accordance with the provisions of the Litigation Reform Act, we are making
investors aware that such forward-looking statements, because they relate to
future events, are by their very nature subject to many important factors that
could cause actual results to differ materially from those contemplated by the
forward-looking statements contained in this Report. Important factors that
could cause actual results to differ from our predictions include those
discussed under this “Management’s Discussion and Analysis” and under “Risk
Factors.” Although we have sought to identify the most significant
risks to our business, we cannot predict whether, or to what extent, any of such
risks may be realized, nor can there be any assurance that we have identified
all possible issues which we might face. In addition, assumptions
relating to budgeting, marketing, product development and other management
decisions are subjective in many respects and thus susceptible to
interpretations and periodic revisions based on actual experience and business
developments, the impact of which may cause us to alter our marketing, capital
expenditure or other budgets, which may in turn affect our financial position
and results of operations. For all of these reasons, the reader is
cautioned not to place undue reliance on forward-looking statements contained
herein, which speak only as of the date hereof. We assume no
responsibility to update any forward-looking statements as a result of new
information, future events, or otherwise except as required by
law. We urge readers to review carefully the risk factors described
in this Quarterly Report, in our Annual Report on Form 10-K for the fiscal year
ended June 30, 2009, as amended, and in the other documents that we file with
the Securities and Exchange Commission. You can read these documents
at
www.sec.gov.
Overview
We
develop, manufacture and sell sophisticated sensors and systems for the
Security, Safety and Defense (“SS&D”) industries. A variety of
technologies are currently used worldwide in security and inspection
applications. In broad terms, the technologies focus on detection in
two major categories: (i) the detection of “bulk” contraband, which includes
materials that would be visible to the eye, such as weapons, explosives,
narcotics and chemical agents; and (ii) the detection of “trace” amounts of
contraband, which includes trace particles or vapors of explosives, narcotics
and chemical agents. Technologies used in the detection of “bulk”
materials include computed tomography, transmission and backscatter x-ray, metal
detection, trace detection and x-ray, gamma-ray, passive millimeter wave, and
neutron analysis. Trace detection techniques include mass
spectrometry, gas chromatography, chemical luminescence, or ion mobility
spectrometry.
We have
developed proprietary technologies used in explosives trace detection (“ETD”)
applications and market and sell handheld and benchtop ETD systems that use our
proprietary ETD technologies. Our products are marketed and sold to a
growing number of locations domestically and internationally. These
systems are used by private companies and government agencies to screen baggage,
cargo, vehicles, other objects and people for the detection of trace amounts of
explosives.
History
Since our
incorporation in August 1984, we have operated as a multi-faceted company
engaging in the development of ion-based technologies and providing commercial
services and products to the semiconductor, medical device and security
industries. As further discussed in the Business Strategy section
below, however, we have recently divested our semiconductor and medical business
activities in order to focus on our security business.
-28-
Semiconductor Business
Unit
Our
business began as a result of the development of our proprietary ion-beam
technology and application of this technology in services to the semiconductor
industry. At the outset, our initial business was to provide ion
implantation services to the semiconductor industry for surface modification of
silicon wafers. Our services were provided to semiconductor
companies, universities and research facilities as an outsource provider of
these ion implantation services. These services were performed at our
Massachusetts facility, where we maintained and operated several ion
implanters.
In
October 2004, we acquired Core Systems Inc., a privately-held semiconductor
wafer processing company located in Sunnyvale, California for $7,486,000 in cash
and common stock of the Company. In February 2008, our Board approved
a formal plan to sell Core as part of our strategic initiative to focus on our
security business. For the three and six months ended December 31,
2008, the operations of Core have been recorded in our statements of operations
as discontinued operations.
In March
2005, we acquired Accurel Systems International Corporation, a privately-held
semiconductor wafer analytical services company located in Sunnyvale, California
for $12,176,000 in cash and common stock of the Company. In March
2007, our Board approved a formal plan to sell Accurel as part of our strategic
initiative to focus on our security business. In May 2007, we
completed the sale of Accurel to Evans Analytical Group LLC in exchange for cash
of $12,705,000, of which $1,000,000 was placed in escrow.
In
February 2008, Evans filed suit requesting rescission of the acquisition
agreement, plus damages, based on claims of misrepresentation and
fraud. In March 2008, Evans filed a claims notice with the escrow
agent prohibiting release of any portion of the escrowed funds pending
resolution of the lawsuit. On March 27, 2009, we announced the
settlement of this litigation and the mutual release by the Company and Evans of
all claims related to the sale of Accurel. In settling this
litigation, we agreed to pay Evans damages in the amount of approximately
$5,700,000 by (i) agreeing to release to Evans approximately $700,000 that had
been held in escrow since the time of the closing and (ii) issuing to Evans
1,000,000 shares of Series E Convertible Preferred Stock having an aggregate
liquidation preference of $5,000,000. Please see more detailed
discussions of the Evans matter in Notes 15 and 23 to our consolidated financial
statements.
Medical Business
Unit
We also
used our ion beam technology to develop ion implantation and thin film coatings
applications for medical devices. As a result of these technologic
advancements, which were in part funded by government research grants and
awards, we were able expand our business and provide services and products to
the medical industry. The primary medical related businesses in which
we engaged were (i) providing services to medical device companies for surface
modification of implantable devices, (ii) the development of brachytherapy
products, and (iii) the manufacture and sales of our proprietary radioactive
seeds for the treatment of prostate cancer.
We
provided ion implantation services to modify orthopedic joint implant surfaces,
resulting in reduced polyethylene wear and increased implant life, through the
second quarter of fiscal 2007. In the second quarter of fiscal 2007,
the customer discontinued its product line using our ion implantation
services. Using similar technology, we developed applications for
coatings of cardiovascular devices, such as coronary stents. In May
1999, we received Food and Drug Administration 510(k) clearance to market our
radioactive seed for the treatment of prostate cancer. We began
commercial sales of our radioactive seed in fiscal 2001.
In
further support of our strategic initiative to focus on our security business,
in June 2007, we sold certain of the assets related to our brachytherapy
products and divested our prostate seed and medical software
businesses. In March 2008, we informed our medical coatings customers
of our intention to discontinue coating operations by the end of the 2008
calendar year. During the three months December 31, 2008 we sold certain assets
associated with our medical coatings and ion implantation
businesses. As of December 31, 2009 and June 30, 2009, the assets and
liabilities of the Medical Business Unit have been recorded on our balance sheet
as held-for-sale. For the three and six months ended December 31,
2009 and 2008, the operations of the Medical Business Unit have been recorded in
our statements of operations as discontinued operations.
-29-
Security Business
Unit
Since May
1999, we have been performing research to improve ETD technology, and
development of ETD products that can be used for detection of trace amounts of
explosives. At present, we have developed both portable and benchtop
systems, which have been marketed and sold both domestically and
internationally. In order to reduce manufacturing costs and be
responsive to large quantity orders, we use a contract
manufacturer. As we continue to sell and deliver our security
products, we work both independently and in conjunction with various government
agencies to develop the next generation of trace explosives detectors and to
identify new applications for our proprietary technology.
In April
2008, we acquired all of the capital stock of Ion Metrics, Inc., located in San
Diego, California. Ion Metrics develops mass sensor systems to detect
and analyze chemical compounds such as explosives, chemical warfare agents,
narcotics, and toxic industrial chemicals for the homeland defense, forensic,
environmental, and safety/security markets. Ion Metrics’ miniaturized
devices and system designs provide high performance and reliability in
combination with low manufacturing costs. Ion Metrics’ operating results have
been included in our statement of operations commencing on April 10,
2008.
Technology
and Intellectual Property
Since May
1999, we have performed research and development in the area of ETD. We have
developed several proprietary technologies in key areas of ETD which we believe
improve the harvesting, collection and detection of trace particles and vapors
of explosives substances. In addition, we are continuing our
development efforts to adapt this technology for the detection of narcotics and
other chemical agents. Our intellectual property portfolio contains
17 security-related patents and patents pending: eight issued United
States patents, eight United States patents pending, and one licensed
patent. We believe that our portfolio of patents and patents pending
provides extensive protection in sample harvesting, sample detection and
collection. A key to our past and future success is our ability to
innovate and offer differentiation in these areas.
We
compartmentalize ETD into four major areas: (i) harvest, (ii) transport, (iii)
analysis, and iv) reporting. These technologies are discussed in
detail in the following sections.
Harvest
- Aerosol Particle Release
Tiny
particles of explosives and narcotics are “sticky” and may adhere to
surfaces. Particles could be transferred if an object, such as
fingers or clothing, comes in contact with a particle. We have
demonstrated that a person touching an explosives material can transfer
explosives particles to numerous other objects leaving a trail of particles
behind.
Our
competitors commonly swipe a surface to be interrogated for explosives particles
with cloth or paper. We believe that this “contact” methodology
provides an effective but inconsistent method of harvesting sample as compared
to an automated, non-contact collection of the trace sample. We have
developed a method, which we believe to be more efficient, using an aerosol of
fine dry ice particles. This technique, which is surprisingly
inexpensive to use, could increase collection sensitivity substantially and
eliminate direct contact with a surface. Our aerosol technology
functions as a very gentle version of “sandblasting” and is safe for almost all
surfaces. Since dry ice sublimes into gas, no residue is left behind,
and the aerosol may be used indoors. We have two patents pending on
this methodology.
Transport
Vortex
Sampling
Once the
trace particle has been released from a surface, it has to be transported to a
collection point. Vortex sampling was the first of our sampling
innovations. We have three patents issued and two patents pending in
the area of vortex sampling methodology.
Our
vortex is similar to a miniature tornado. A hollow spinning cylinder
of air flowing outward surrounds and protects an inner vacuum flowing
inward. This vortex sampling technology enables particles released
within the vortex, or blown into it, to be transported with high efficiency to a
collection filter.
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Long-Life Sample
Trap
Once
particles have been liberated from the surface being interrogated, the particles
are transported to our innovative trapping filter, which is an ultra-fine
stainless steel woven mesh. The trapping filter has a long usable
life, which could span several years, requiring inexpensive, routine
maintenance. We believe the trapping filter provides an innovative
solution to the more costly consumables used by several of our competitors
engaged in ETD using contact methodology for sampling and
detection.
Analysis
Flash
Desorption
Flash
desorption is an optical method for converting the chemistry of a particle, such
as the chemicals composing explosives or narcotics, into a vapor that can be
subjected to analyses for the discrimination of chemical
properties. In conventional trace chemical detectors, a sample is
slowly warmed in an oven producing diluted vapor with low chemical
concentrations. Optical flash vaporization heats a sample within
microseconds, producing a high sample concentration for detection.
This
method is not appropriate with conventional sample collection methods, such as
paper wipes, because the paper is white, and the light from the bright flash
reflects off, producing little heating. However, by using our
trapping filter, a very fast detection response can be achieved without loss in
sensitivity. We have two patents issued and one patent pending in the
area of flash desorption methodology. The first product under
development to take advantage of our flash desorption technology is our air
cargo screening system described under “Products” below.
Photonic
Ionization
The
conventional method of ionizing vapors for analysis is to use a radioactive beta
source. While ETD equipment using radioactive sources are simple,
effective, and need no electricity in the ionization process, there are
important issues involving safety, licensing, regular verification of source
integrity, and disposal. Some markets, such as Japan and Australia,
are known to reject instruments with radioactive sources. We believe
that most markets would prefer not to have to address the issues surrounding ETD
equipment with radioactive sources.
We have
developed two types of photonic, non-radioactive ion sources for our instruments
for applications requiring either the ionization of positive ions or negative
ions. These ion sources may be found individually or in combination
within our products, depending on the application for which the ETD equipment is
to be used. We have two patents pending in the area of photonic
ionization.
Reporting
Reporting
is that portion of the cycle that displays and stores information generated
during the analysis phase. This is the information a system operator
sees and that indicates if an alarm condition exists or if the test is
negative. Information can be displayed in both graphical and tabular
formats. The reporting also indicates when the instrument is ready
for the next sample as well as displaying built-in system
diagnostics.
Products
We have
developed several explosives detection systems designed for use in aviation and
transportation security, high threat facilities and infrastructure, military
installations, customs and border protection, and mail and cargo
screening. The systems use our proprietary Quantum SnifferTM
technologies, including photon-based, non-radioactive ion source in combination
with ion mobility spectrometry, a classic detection tool sensitive to the unique
speeds with which ions of various substances move through the air (“IMS”) to
electronically detect minute quantities of explosives vapor and
particles.
-31-
Current
Products
Quantum SnifferTM QS-H150 Portable Explosives
Detector
The
Quantum Sniffer QS-H150 Portable Explosives Detector employs a patented vortex
collector for the simultaneous detection of explosives particulates and vapors
with or without physical contact and in real-time. We believe that
our advanced QS-H150 is more sensitive than other detection
devices. The QS-HS150 can detect vapors and nanogram quantities of
explosives particulates for most explosives substances considered to be
threats. Such substances include, but are not limited to, military
and commercial explosives, improvised and homemade explosives, and propellants
and taggants.
The
QS-H150 has automatic and continuous self-calibration. It monitors
its environment, senses changes that would affect its accuracy, and
re-calibrates accordingly. The system requires no user intervention
and no calibration consumables. The detection process begins with the
collection of a sample with our patented vortex collector. After
collection, the sample is ionized photonically and analyzed using IMS
technology. The presence of a threat substance is indicated by a
visible and audible alarm. The threat substance is then identified
and displayed on the integrated LCD screen. Optionally, and at any
time, a monitor and keyboard may be connected for convenient access to
spectrogram display and analysis tools, administrative tools, and
diagnostics.
When
detecting a threat substance, the QS-H150 rapidly alarms. This
real-time detection limits equipment contamination and allows for fast
clear-down. Operation and maintenance are
cost-effective. Since there is no requirement for dopants,
calibration consumables or verification consumables, the overall cost of
consumables is minimized. Routine maintenance consists only of care
and cleaning using common supplies, and desiccant replacement as
required. No radioactive material is used in the QS-H150, so there
are no associated certifications, licenses, inspections, or end-of-life disposal
issues.
Quantum SnifferTM QS-B200 Benchtop Explosives
Detector
The
QS-B200 Benchtop Explosives Detector uses dual IMS with non-radioactive
ionization for the detection and identification of a wide range of military,
commercial, and improvised explosives. The QS-B200 has automatic and
continuous self-calibration. It monitors its environment, senses
changes that would affect its accuracy, and re-calibrates
accordingly. For detection, the sample is collected with a standard
trap, ionized, and analyzed via IMS. The presence of a threat is
indicated by a visible and audible alarm, and the substance is identified and
displayed on the integrated touch screen display. Users may save data
locally, print via a built-in thermal printer, or send data through standard
interfaces such as USB, LAN, etc. Multi-level password-protected data
security is standard. We believe that the operation and maintenance
of the QS-B200 are extremely cost-effective. Routine maintenance consists only
of care and cleaning using common supplies, and desiccant replacement as
required. No radioactive material is used in the QS-B200, so there
are no associated certifications, licenses, inspections, or end-of-life disposal
issues.
Products
Under Development
Quantum SnifferTM QS-H300 Air Cargo Screening
System
With the
assistance of funding from the U.S. Department of Homeland Security (“DHS”), we
have developed a hand sampler detector that utilizes our proprietary jetted
vortex collector for non-contact collection of trace particulate
materials. We believe the hand sampler, which will be a compact,
lightweight device, could significantly improve explosives detection
capabilities while also being very user friendly. Our non-contact
method could prove to be more effective than traditional contact sample
collection methods, and at a much lower cost to users. This improved
sampling process has applicability for use in detecting trace amounts of
explosives found on a wide range of objects such as carry-on luggage, parcels,
packages and cargo. In addition, multiple handheld sampling units
could be systematically deployed in concert with a centralized trace explosives
detection system to improve efficiency and increase the number of articles
screened. We believe this product could usher in a new way of
thinking about how cargo and other items can be properly examined in a
cost-effective and user friendly manner. We introduced the QS-H300 at
the AVSEC 2008 exhibition in Seoul, South Korea in November 2008.
-32-
Miniature Mass
Spectrometer
We
initially developed our own proprietary ion mobility spectrometer. We believe
that as market demand grows for greater precision of substance identification
and the list of substances to be detected increases, more advanced detectors
will be required.
Our
acquisition of Ion Metrics enabled us to obtain miniaturized quadrupole mass
spectrometry (“QMS”) detector technology. The QMS detector is roughly
the size of an AA battery and has low manufacturing costs. When used
in conjunction with an IMS, the QMS detector senses the molecular weight of the
chemical species resulting in an “orthogonal” detection method in which a more
fundamental characteristic of a substance is measured. We believe
that, because it is unlikely that two substances would share the same mass and
the same ion mobility in air, QMS detector technology improves the accuracy of
detection and minimizes false alarms. We are currently developing
interfaces for integrating the QMS detector into our future
products.
Hyphenated
Detectors
Depending
on the application and the number of “interfering” background chemicals, it may
be necessary to incorporate additional “orthogonal” detection
methods. The combination of multiple sensors is commonly known as
hyphenated systems. By measuring different properties of the same
species, interferents are separated from target species for a deterministic
detection and identification and have minimum rates of false alarms. The
combination of these sensors in series is commonly known as employing
“hyphenated” detection methods. A hyphenated system is one in which a
sequence of different types of detectors all must agree that an alarm has
occurred before a valid alarm is declared.
We are
currently developing hyphenated systems employing conventional ion mobility,
differential mobility and mass spectrometry for the DHS.
We
believe detection systems incorporating hyphenated detection methods could
accelerate the expansion of our product line to more effectively address the
needs of the security, safety and defense sector, as well as accelerate our
entry into the narcotics, chemical warfare, biological warfare and toxic
industrial chemical detection marketplaces. Combining new
technologies with our other innovative products could enhance our competitive
position while improving sales volumes and product margins in the future.
We expect hyphenated systems
to appear in our future product offerings.
Manufacturing
Operations
We
manufacture our security products primarily through a sole source contract
manufacturer located locally in Worcester, Massachusetts. We believe
our strategy to outsource manufacturing reduces manufacturing costs, improves
scheduling flexibility, and allows us to focus our internal resources and
management on product development, marketing, sales and
distribution. We also maintain an internal production group at our
corporate headquarters in Wilmington, Massachusetts responsible for
pre-production logistics, oversight of contract manufacturing, quality control
and inventory management.
Critical
Accounting Policies
Our
significant accounting policies are summarized in Note 2 to our consolidated
financial statements included in Item 7 of our Annual Report on Form 10-K, as
amended, for the fiscal year ended June 30, 2009. However, certain of
our accounting policies require the application of significant judgment by our
management, and such judgments are reflected in the amounts reported in our
condensed consolidated financial statements. In applying these
policies, our management uses our judgment to determine the appropriate
assumptions to be used in the determination of estimates. Those
estimates are based on our historical experience, terms of existing contracts,
our observance of market trends, information provided by our strategic partners
and information available from other outside sources, as
appropriate. Actual results may differ significantly from the
estimates contained in our condensed consolidated financial
statements. There has been no change to our critical accounting
policies through the fiscal quarter ended December 31, 2009.
-33-
Results
of Operations
Three Months Ended December
31, 2009 vs. December 31, 2008
Revenues
Security
revenues for the three months ended December 31, 2009 were $603,000 as compared
with $1,519,000 for the comparable prior year period, a decrease of $916,000 or
60.3%. Revenue from security products for the three months ended
December 31, 2009 were $496,000 as compared with $1,207,000 for the comparable
prior year period, a decrease of $711,000 or 58.9%. Revenue from
government-funded contracts for the three months ended December 31, 2009 were
$107,000 as compared with $312,000 for the comparable prior year period, a
decrease of $205,000 or 65.7%. The decrease in security revenue is
primarily a result of a decrease in the number of units sold of our explosives
detection products during the three months ended December 31, 2009 as compared
to the comparable prior year period. In the prior period, we made several
shipments of our handheld explosives detection equipment to customers in China
and India. Revenue from government contracts decreased due to the expiration of
several contracts in the three-month period ended December 31, 2009 which could
result in reduced government contract revenues in fiscal 2010, unless we are
successful in securing additional government contracts. We will continue to
pursue these grants and contracts to support our research and development
efforts in the areas of trace explosives detection
Cost
of Revenues
Cost of
revenues for the three months ended December 31, 2009 were $477,000 as compared
with $881,000 for the comparable prior year period, a decrease of $404,000 or
45.9%. The decrease in cost of revenues is primarily a result of the
decrease in unit sales of security product in the three months ended December
31, 2009.
Gross
Margin
Gross
margin for the three months ended December 31, 2009 was $126,000 or 20.9% of
security revenues as compared with gross margin of $638,000 or 42.0% of security
revenues for the comparable prior year period. The decrease in gross
margin is a result of competitive pricing pressures, an increase in quality
assurance costs, minimum guaranteed royalties due on licensed technology and
increased per unit manufacturing overhead, as overhead costs were allocated to a
reduced volume.
Research,
Development and Regulatory Expenses
Research
and development expense for the three months ended December 31, 2009 was
$576,000 as compared with $751,000 for the comparable prior year period, a
decrease of $175,000 or 23.3%. We continue to expend funds to further
the development of new products in the areas of explosives detection, as well as
to prepare for certain government laboratory acceptance testing. The
decrease in research and development expenses in the three months ended December
31, 2009 is due primarily to decreased payroll and related fringe benefits costs
resulting from a reduction in personnel.
Selling,
General and Administrative Expenses
Selling,
general and administrative expenses for the three months ended December 31, 2009
was $842,000 as compared with $1,561,000 for the comparable prior year period, a
decrease of $719,000, or 46.1%. The decrease in selling, general and
administrative expenses is due primarily to decreased rent and related occupancy
costs, decreased payroll and related fringe benefits costs resulting from a
reduction in personnel, decreased legal fees, partially offset by increased loan
financing fees.
Lease
Termination Benefit
For the
three months ended December 31, 2009, we recorded a lease termination benefit of
$384,000 as compared with $0 for the comparable prior year
period. The lease termination benefit resulted from the dismissal of
litigation related to Accurel’s lease obligations in California on October 28,
2009. Accurel has no further obligations or liabilities to the lessor under its
lease.
-34-
Other
Income and Expense, Net
For the
three months ended December 31, 2009, we recorded other expense, net of $716,000
as compared with other expense, net of $416,000, for the comparable prior year
period, an increase of $300,000. The increase was due primarily to increased
borrowings under our credit facility with DMRJ Group, LLC and to higher interest
rates on these borrowings. For the three months ended December 31,
2008, interest expense included $568,000 assessed on the Series D Preferred
Stock due to our failure to meet the amended redemption date, and $90,000 of
forbearance fees due to cure events of default under our former credit
facility. Other factors attributing to the increase in other expense,
net are: the realized gain of $468,000 on the transfer of our
investment in CorNova common stock in connection with the senior secured
convertible promissory note issued to DMRJ in December 2008 and the realization
of the $123,000 unrealized loss of our share of CardioTech International, Inc.
stock owned by CorNova, Inc., a privately-held, development stage medical device
company, in the three months ended December 31, 2008. Interest income increased
$2,000 to $14,000, in the three months ended December 31, 2009 from $12,000, for
the comparable prior year period, due to interest income associated with the
note receivable issued to us as part of the Core asset sale.
Loss
from Continuing Operations
Loss from
continuing operations for the three months ended December 31, 2009 was
$1,624,000 as compared with a loss of $2,090,000 for the comparable prior year
period, a decrease of $466,000, or 22.3%. The decrease in loss from
continuing operations is due primarily to a decrease in operating expenses and
recognition of the lease termination benefit.
Preferred
Distribution, Dividends and Accretion
Preferred
distribution, dividends and accretion on the Series D Preferred Stock for the
three months ended December 31, 2009 was $0 as compared with $18,000 for the
comparable prior year period, a decrease of $18,000. The Series D
Preferred Stock was extinguished on December 10, 2008.
Income
(Loss) from Discontinued Operations
The net
income from discontinued operations for the three months ended December 31, 2009
was $0, as compared with income from discontinued operations of $29,000 for the
comparable prior year period, a decrease of $29,000. Income from
discontinued operations for the three months ended December 31, 2008 includes:
(i) gain on sale of Core Systems of $22,000, (ii) loss of $94,000 from
operations of our medical reporting unit, (iii) income of $8,000 from the
operations of semiconductor business, and (iv) a gain on sale of assets of our
medical reporting unit of approximately $93,000.
Six Months Ended December
31, 2009 vs. December 31, 2008
Revenues
Security
revenues for the six months ended December 31, 2009 were $2,423,000 as compared
with $7,467,000 for the comparable prior year period, a decrease of $5,044,000
or 67.6%. Revenue from security products for the six months ended
December 31, 2009 were $2,131,000 as compared with $6,509,000 for the comparable
prior year period, a decrease of $4,378,000 or 67.3%. Revenue from
government-funded contracts for the six months ended December 31, 2009 were
$292,000 as compared with $958,000 for the comparable prior year period, a
decrease of $666,000 or 69.5%. The decrease in security revenue is
primarily a result of a decrease in the number of units sold of our explosives
detection products during the six months ended December 31, 2009 as compared to
the comparable prior year period. In the prior period, we made significant
shipments of our handheld explosives detection equipment to a customer in China,
aggregating approximately $4,169,000 in sales, which shipments coincided with
security preparations for the 2008 Beijing Olympics, and we made several
shipments of our handheld explosives detection equipment to customers in China
and India in the six months ended December 31, 2008. Revenue from government
contracts decreased due to the expiration of several contracts in the six-month
period ended December 31, 2009, which could result in reduced government
contract revenues in fiscal 2010, unless we are successful in securing
additional government contracts. We will continue to pursue these grants and
contracts to support our research and development efforts in the areas of trace
explosives detection.
-35-
Cost
of Revenues
Cost of
revenues for the six months ended December 31, 2009 were $1,456,000 as compared
with $4,053,000 for the comparable prior year period, a decrease of $2,597,000
or 64.1%. The decrease in cost of revenues is primarily a result of
the decrease in unit sales of security product in the six months ended December
31, 2009.
Gross
Margin
Gross
margin for the six months ended December 31, 2009 was $967,000 or 39.9% of
security revenues as compared with gross margin of $3,414,000 or 45.7% of
security revenues for the comparable prior year period. The decrease
in gross margin is a result of competitive pricing pressures, increased per unit
manufacturing overhead, as overhead costs were allocated to a reduced volume, an
increase in quality assurance costs and minimum guaranteed royalties due on
licensed technology.
Research,
Development and Regulatory Expenses
Research
and development expense for the six months ended December 31, 2009 was
$1,171,000 as compared with $1,771,000 for the comparable prior year period, a
decrease of $600,000 or 33.9%. We continue to expend funds to further
the development of new products in the areas of explosives detection, as well as
to prepare for certain government laboratory acceptance testing. The
decrease in research and development expenses in the six months ended December
31, 2009 is due primarily to decreased payroll and related fringe benefits costs
resulting from a reduction in personnel and reduced engineering consulting
fees.
Selling,
General and Administrative Expenses
Selling,
general and administrative expenses for the six months ended December 31, 2009
was $2,069,000 as compared with $3,927,000 for the comparable prior year period,
a decrease of $1,858,000, or 47.3%. The decrease in selling, general
and administrative expenses is due primarily to decreased payroll and related
fringe benefits costs resulting from a reduction in personnel, decreased
variable selling expenses due to the significant decrease in sales of our
security products, decreased rent and related occupancy costs and decreased
legal and audit fees, partially offset by an increase in consulting fees and
increased loan financing fees.
Lease
Termination Benefit
For the
six months ended December 31, 2009, we recorded a lease termination benefit of
$384,000 as compared with $0 for the comparable prior year
period. The lease termination benefit resulted from the dismissal of
litigation related to Accurel’s lease obligations in California on October 28,
2009. Accurel has no further obligations or liabilities to the lessor under its
lease.
Other
Income and Expense, Net
For the
six months ended December 31, 2009, we recorded other expense, net of $1,364,000
as compared with other expense, net of $440,000, for the comparable prior year
period, an increase of $924,000. The increase in other expense, net
is primarily a result of an increase in interest expense of $591,000 due to
increased borrowings under our credit facility with DMRJ Group, LLC and to
higher interest rates on these borrowings. For the six months ended
December 31, 2008, interest expense included $568,000 assessed on the Series D
Preferred Stock due to our failure to meet the amended redemption date, and
$90,000 of forbearance fees due to cure events of default under our former
credit facility. Other factors attributing to the increase in other
expense, net are: the realized gain of $468,000 on the transfer of
our investment in CorNova common stock as part of the senior secured convertible
promissory note issuance and the realization of the $123,000 unrealized loss of
our share of CardioTech International stock owned by CorNova in the three months
ended December 31, 2008. Interest income increased $12,000 to $32,000, in the
six months ended December 31, 2009 from $20,000, for the comparable prior year
period, due to interest income associated with the note receivable issued to us
as part of the Core asset sale.
Loss
from Continuing Operations
Loss from
continuing operations for the six months ended December 31, 2009 was $3,253,000
as compared with a loss of $2,724,000 for the comparable prior year period, an
increase of $529,000, or 19.4%. The increase in loss from continuing
operations is due primarily to decreased sales of our security products, an
increase in interest expense and the realized gain of $468,000 on the transfer
of our investment in CorNova common stock in the six months ended December 31,
2008, offset partially by a decrease in operating expenses and recognition of
the lease termination benefit.
-36-
Preferred
Distribution, Dividends and Accretion
Preferred
distribution, dividends and accretion on the Series D Preferred Stock for the
six months ended December 31, 2009 was $0 as compared with $207,000 for the
comparable prior year period, a decrease of $207,000. The Series D
Preferred Stock was extinguished on December 10, 2008.
Income
(Loss) from Discontinued Operations
The net
loss from discontinued operations for the six months ended December 31, 2009 was
$20,000 as compared with income from discontinued operations of $1,019,000 for
the comparable prior year period, a decrease of $1,039,000. The net
loss from discontinued operations for the six months ended December 31, 2009 is
composed of operating loss of $20,000 from our medical reporting
unit. Income from discontinued operations for the six months ended
December 31, 2008 includes: (i) loss of $51,000 from operations of our medical
reporting unit, (ii) income of $24,000 from the operations of semiconductor
business, (iii) gain on sale of Core Systems of $22,000 and (iv) a gain on sale
of assets of our medical reporting unit of approximately
$1,024,000.
Liquidity
and Capital Resources
As of
December 31, 2009, we had approximately $25,000 of cash and cash equivalents, an
increase of $25,000 when compared with a balance of $0 as of June 30,
2009. On June 10, 2010, we must repay in full our obligations to DMRJ
under the amended and restated senior secured promissory note issued to DMRJ in
March 2009, under a
second secured promissory note issued in July 2009 and under a revolving credit
facility established in September 2009. As of December 31, 2009, our
obligations under the two promissory notes and under the revolving credit
facility were $4,480,000, $1,000,000 and $1,819,000, respectively. Each of these
notes and the credit facility are described in more detail below. As
of February 5, 2009 our obligation to DMRJ under the two senior notes and under
the revolving credit facility were $4,180,000, $1,000,000 and $2,620,000,
respectively.
During
the six months ended December 31, 2009 we had net cash outflows of $3,016,000
from operating activities of continuing operations as compared to net cash
outflows from operating activities of continuing operations of $2,236,000 for
the comparable prior year period. The $780,000 decrease in net cash
used in operating activities of continuing operations during the six months
ended December 31, 2009, as compared to the comparable prior year period, was
primarily a result of (i) an increase in our loss from operations of $529,000
due to lower sales of our security products, (ii) a decrease in accounts
payable, of $1,713,000 due to the payment of outstanding obligations and (iii) a
decrease of $276,000 in deferred revenue due primarily due the timing of
customer advance payments, partially offset by a $302,000 decrease in accounts
receivable, a $638,000 decrease in prepaid expenses and other current assets and
a $198,000 decrease in inventories.. For the six months ended December 31, 2009,
we had net cash inflows of $17,000 from operating activities of discontinued
operations, compared with net cash inflows of $36,000 from operating activities
of discontinued operations for the comparable prior year period, a decrease of
$19,000, due a decrease in cash provided by accounts receivable in the six
months ended December 31, 2009.
During
the six months ended December 31, 2009 we had net cash inflows of $214,000 from
investing activities of continuing operations as compared to net cash inflows of
$2,872,000 from investing activities of continuing operations for the comparable
prior year period. The $2,658,000 decrease in net cash provided by
investing activities of continuing operations during the three months ended
December 31, 2009, as compared to the comparable prior year period, was
primarily a result of cash provided from the sale of assets of our medical
business unit, net proceeds received from the sale of Core Systems and payments
received on the note issued as part of the consideration received from the sale
of Core Systems. For the six months ended December 31, 2009, we had no net cash
outflows from investing activities of discontinued operations, compared to net
cash outflows of $28,000 from investing activities of discontinued operations
for the comparable prior year period, due primarily to a decrease in cash used
to purchase property and equipment.
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During
the six months ended December 31, 2009 we had net cash inflows of $2,810,000
from financing activities of continuing operations as compared to net cash
outflows of $331,000 from financing activities of continuing operations for the
comparable prior year period. The $3,141,000 increase in net cash
from financing activities of continuing operations during the six months ended
December 31, 2009, as compared to the comparable prior year period, was
primarily a result of $1,000,000 in cash provided by the issuance of a senior
secured note to DMRJ in July 2009 and $1,819,000 in cash provided by the credit
facility provided by DMRJ in September 2009. During the six months
ended December 31, 2008, we used $2,776,000 to pay dividends and redeem our
Series D Preferred Stock, used $1,000,000 to repay our obligations under a
senior secured convertible promissory note, used $764,000 to reduce our
obligations to Bridge Bank under our term note and revolving credit facility,
used $299,000 to repay other long-term debt and capital lease obligations and
received $4,484,000 from our issuance of a senior secured convertible promissory
note to DMRJ. For the six months ended December 31, 2009, we had no net cash
outflows from financing activities of discontinued operations compared with net
cash outflows of $1,000 from financing activities of discontinued operations for
the comparable prior year period, due to decreased principal payments of capital
lease obligations. We expect that the absence of cash flows from our
discontinued operations will not have a negative impact on our future liquidity
and capital resources.
On
December 10, 2008, we entered into a note and warrant purchase agreement with
DMRJ Group LLC, an accredited institutional investor, pursuant to which we
issued a senior secured convertible promissory note in the principal amount of
$5,600,000 and a warrant to purchase 1,000,000 shares of our common
stock. The note, which is collateralized by all of our assets,
originally bore interest at 11.0% per annum. The effective interest
rate on the note as of the date of issuance was approximately
23.4%. We prepaid interest in the amount of $616,000 upon the
issuance of the note. In lieu of paying any commitment fees, closing
fees or other fees in connection with the purchase agreement, we transferred our
entire interest in 1,500,000 shares of the common stock of CorNova, Inc., a
privately-held development stage medical device company, to DMRJ. The
note, which has been amended and restated, as described below, was originally
convertible in whole or in part at the option of DMRJ into shares of our common
stock at a conversion price of $0.26 per share.
We valued
the note upon issuance at its residual value of $4,356,000 based on the fair
values of the financial instruments issued in connection with this convertible
debt financing, including the warrant, the original issue discount and the fair
value of the CorNova common stock transferred to DMRJ. The amounts
recorded in the financial statements represents the amounts attributed to the
senior secured convertible debt of $5,600,000, net of $160,000 allocated to the
warrant, $616,000 of original issue discount and $468,000 representing the
estimated fair value of the CorNova common stock. The warrant was
valued using the Black-Scholes model with the following
assumptions: volatility 98.4%, risk-free interest rate of 2.29%,
expected life of five years and expected dividend yield of 0.00%. As
required under the terms of the note, we made a principal payment of $1,000,000
on December 24, 2008. The note required us to make a principal
payment in an amount equal to any funds released from the escrow created in
connection with the May 2007 sales of the assets of Accurel Systems
International, upon the release of such funds. DMRJ
waived that requirement in connection with the settlement of the Evans
litigation.
On March
12, 2009, we entered into a letter agreement with DMRJ pursuant to which we were
granted access to $250,000 of previously restricted cash out of funds held in a
blocked account. The effect of the letter agreement made $250,000
available to us until the close of business on April 14, 2009. In consideration
of the letter agreement, on March 12, 2009, we issued an amended and restated
senior secured convertible promissory note and amended and restated warrant to
DMRJ to purchase shares of common stock, which replaced the note and warrant
issued on December 10, 2008. The terms of the amended and restated
note and the amended and restated warrant are identical to the terms of the
original note and warrant, except that the amended instruments reduced the
initial conversion price of the original note from $0.26 to $0.18 and reduced
the initial exercise price of the original warrant from $0.26 to
$0.18.
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The note
contains restrictions and financial covenants including: (i) restrictions
against declaring or paying dividends or making any distributions; against
creating, assuming or incurring any liens; against creating, assuming
or incurring any indebtedness; against merging or consolidating with any other
company, provided,
however, that a merger or consolidation is permitted if we are the
surviving entity; against the sale, assignment, transfer or lease of our assets,
other than in the ordinary course of business and excluding inventory and
certain asset sales expressly permitted by the note purchase agreement; against
making investments in any company, extending credit or loans, or purchasing
stock or other ownership interest of any company; and (ii) covenants that we
have authorized or reserved for the purpose of issuance, 150% of the aggregate
number of shares of our common stock issuable upon exercise of the
warrant; that we maintain a minimum cash balance of at least
$500,000; that the aggregate dollar amount of all accounts payable be
no more than 100 days past due; and that we maintain a current ratio, defined as
current assets divided by current liabilities, of no less than 0.60 to
1.00.
On July
1, 2009, we entered into an amendment to the December 10, 2008 note and warrant
purchase agreement with DMRJ, pursuant to which we issued a senior secured
promissory note to DMRJ in the principal amount of $1,000,000.
The note,
which has been amended, as described below, originally bore interest at the rate
of 2.5% per month. The principal balance of the note, together with all
outstanding interest and all other amounts owed under the note, was originally
due and payable on the earlier of (i) December 10, 2009 and (ii) the receipt by
us of net proceeds of at least $3,000,000 from the issuance of debt and/or
equity securities in one or more transactions. In addition, at our option, DMRJ
may require us to prepay such amounts upon (i) certain consolidations, mergers
and business combinations involving us; (ii) the sale or transfer of more than
50% of our assets, other than inventory sold in the ordinary course of business,
in one or more related or unrelated transactions; or (iii) the issuance by us,
in one or more related or unrelated transactions, of any equity securities or
securities convertible into equity securities (other than options granted to
employees and consultants pursuant to employee benefit plans approved by our
Board of Directors), which results in net cash proceeds to us of more than
$500,000; provided,
however, that DMRJ may not require us to prepay more than the net cash
proceeds of any transaction described in the preceding clause (iii) of this
sentence. We may prepay all or any portion of the principal amount of the note,
without penalty or premium, after prior notice to DMRJ.
The
amendment to the loan agreement provides that, in the event we have not obtained
net proceeds from the issuance of debt or equity securities upon terms and
conditions acceptable to DMRJ in its sole discretion of (i) $1,000,000 by July
24, 2009 and (ii) to the extent that we satisfied such requirements, an
additional $2,000,000 by August 21, 2009, we will immediately engage in a sale
process satisfactory to DMRJ in its sole discretion by implementing a
contingency plan which may be established by DMRJ, including, without
limitation, the engagement at our expense of a third party investment banker
acceptable to DMRJ in its sole discretion. We did not satisfy these
requirements and, in August 2009, we engaged Pickwick Capital Partners to market
our company for sale.
In
connection with the additional note issued on July 1, 2009, we also issued
871,763 shares of our Series F Convertible Preferred Stock to DMRJ, and agreed
that, if we were unable to obtain net proceeds of at least $3,000,000 from the
issuance of debt and/or equity securities by August 31, 2009, we would issue
774,900 additional shares of Series F Preferred Stock to DMRJ. DMRJ later
extended this deadline until October 1, 2009. We did not satisfy this
requirement and, on October 1, 2009, we issued the additional shares to DMRJ.
All of the 1,646,663
shares of Series F Preferred Stock held by DMRJ are convertible into 25%
of our common stock, calculated on a fully diluted basis. In addition, for so
long as the July 2009 note or the amended and restated senior secured
convertible promissory note issued to DMRJ in March 2009 remain outstanding, we
may not issue additional shares of common stock, or other securities convertible
into or exercisable for common stock, if such securities would increase the
number of shares of our common stock, calculated on a fully diluted basis, unless we simultaneously
issue to DMRJ that number of additional shares of Series F Preferred Stock which
is necessary to result in the number of shares of common stock into which all
Series F Preferred Stock held by DMRJ may be converted representing the same
percentage ownership of our common stock on a fully diluted basis after such
issuance as immediately prior thereto. We calculated the value of the
Series F Preferred Stock to be $378,000, which amount represents 25% of the fair
value of the Company on the date of issuance based on the market capitalization
as of that date.
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After the
repayment in full of the promissory notes, described above, the number of shares
of common stock into which the Series F Preferred Stock is convertible will
remain subject to “full ratchet” antidilution protection in the event that we
issue additional shares of common stock (or securities convertible into or
exercisable for additional shares of common stock) at a price below $.08 per
share. “Full ratchet” antidilution protection completely protects an investor’s
investment from subsequent price erosion until the occurrence of a liquidity
event. The anti-dilution protection will not apply, however, to issuances of
stock and options to our employees, directors, consultants and advisors pursuant
to any equity compensation plan approved by our stockholders.
The
Series F Preferred Stock is entitled to participate on an “as converted” basis
in all dividends or distributions declared or paid on our common stock. In the
event of any liquidation, dissolution or winding up of our company, the holders
of the Series F Preferred Stock will be entitled to be paid an amount equal to
$.08 per share of Series F Preferred Stock, plus any declared but unpaid
dividends, prior to the payment of any amounts to the holders of our Series E
Convertible Preferred Stock or common stock by reason of their ownership of such
stock.
The
holders of the Series F Preferred Stock have no voting rights except as required
by applicable law. However, without the consent of the holders of a majority of
the Series F Preferred Stock, we may not (i) amend, alter or repeal any
provision of our Amended and Restated Articles of Organization or By-laws in a
manner that adversely affects the powers, preferences or rights of the Series F
Preferred Stock; (ii) authorize or issue any equity securities (or any equity or
debt securities convertible into equity securities) ranking prior and superior
to the Series F Preferred Stock with respect to dividends, distributions,
redemption rights or rights upon liquidation, dissolution or winding up; or
(iii) consummate any capital reorganization or reclassification of any of our
equity securities (or debt securities convertible into equity securities) into
equity securities ranking prior and superior to the Series F Preferred Stock
with respect to dividends, distributions, redemption rights or rights upon
liquidation, dissolution or winding up.
On August
5, 2009, we entered into a second amendment to the December 10, 2008 note and
warrant purchase agreement with DMRJ, pursuant to which we issued DMRJ a bridge
note in the principal amount of $700,000. The note bore interest at
the rate of 25% per annum. The outstanding principal balance and all interest
due under this bridge note was paid on September 4, 2009.
On
September 4, 2009, we entered into an additional credit agreement with DMRJ,
pursuant to which DMRJ provided us with a revolving line of credit in the
maximum principal amount of $3,000,000. In connection with the credit agreement,
we issued a promissory note to DMRJ evidencing our obligations under the credit
facility. Each of our subsidiaries guaranteed our obligations under the credit
facility. Our obligations and our subsidiaries’ obligations are secured by
grants of first priority security interests in all of our respective assets. In
addition, we agreed to cause all of our receivables and collections to be
deposited in a bank deposit account pledged to DMRJ pursuant to a blocked
account agreement. All funds deposited in the blocked collections account will
be applied towards the repayment of our obligations to DMRJ under the note.
Until the note and all of our obligations thereunder have been paid and
satisfied in full, we will have no right to access or make withdrawals from the
blocked account without DMRJ’s consent.
The note,
which has been amended, as described below, originally bore interest at the rate
of 25% per annum. Interest under the note will be due on the first day of each
calendar month. The principal balance of the note, together with all outstanding
interest and all other amounts owed under the note, was originally due and
payable on December 10, 2009. We may prepay all or any portion of the principal
amount of the note, without penalty or premium, after prior notice to DMRJ.
Subject to applicable cure periods, amounts due under the note are subject to
acceleration upon certain events of default, including: (i) any failure to pay
when due any amount owed under the note; (ii) any failure to observe or perform
any other condition, covenant or agreement contained in the note or certain
conditions, covenants or agreements contained in the credit agreement; (iii)
certain suspensions of the listing or trading of our common stock; (iv) a
determination that any misrepresentation made by us to DMRJ in the credit
agreement or in any of the agreements delivered to DMRJ in connection with the
credit agreement were false or incorrect in any material respect when made; (v)
certain defaults under agreements related to any of our other indebtedness; (vi)
the institution of certain bankruptcy and insolvency proceedings by or against
us; (vii) the entry of certain monetary judgments against us that are not
dismissed or discharged within a period of 20 days; (viii) certain cessations of
our business in the ordinary course; (ix) the seizure of any material portion of
our assets by any governmental authority; and (x) our indictment for any
criminal activity.
-40-
In lieu
of paying DMRJ any commitment fees, closing fees or other fees in connection
with the credit agreement, we agreed to pay DMRJ an additional amount equal to
50% of or aggregate net profits, as defined, generated between the closing date
through the termination of the credit facility. Such payments will be due and
payable as earned upon (i) each request for an advance under the note, and (ii)
the termination of the credit facility. For the period September 4,
2009 through December 31, 2009, we experienced a net loss and no such payments
were due or payable to DMRJ as of December 31, 2009.
Upon the
closing of the credit facility, we requested and were granted an initial advance
of approximately $1,633,000, of which we used approximately $715,000 to repay
all of our outstanding indebtedness to DMRJ pursuant to the bridge note issued
to DMRJ on August 5, 2009, and approximately $548,000 to retire certain
obligations owed to other parties. We used the balance of the initial advance
for working capital and ordinary course general corporate purposes.
On
December 20, 2009, we received written notice from DMRJ, stating that we were in
default of our obligations under each of the promissory notes described above.
On December 10, 2009, we failed to pay an aggregate of $7,505,678 in principal,
together with approximately $149,292 of interest, due on such date to DMRJ upon
the maturity of those notes.
As a
result of these defaults, effective December 11, 2009, (i) the interest rate
that we are obligated to pay to DMRJ under the promissory note issued in March
2009 automatically increased from 11% per annum to 2.5% per month (or the
maximum applicable legal interest rate, if less); (ii) the interest rate that we
are obligated to pay to DMRJ under the promissory note issued in July 2009
automatically increased from 2.5% per month to 3.0% per month (or the maximum
applicable legal interest rate, if less); and (iii) the interest rate that we
are obligated to pay to DMRJ under the promissory note issued in September 2009
increased from 25% per annum to 30% per annum (or the maximum applicable legal
interest rate, if less). All such default interest is payable upon demand by
DMRJ.
On
December 31, 2009, we received written notice from DMRJ, withdrawing its
December 20, 2009 default notice. Also on December 31, 2009, DMRJ elected to
convert $120,000 of the principal amount owed by us under one of the promissory
notes into 1,500,000 shares of our common stock, at an adjusted conversion price
of $.08 per share. DMRJ has subsequently converted additional portions of our
indebtedness on similar terms. Under the promissory notes and related
agreements, however, DMRJ may not convert any portion of the notes if the number
of shares of common stock to be issued pursuant to such conversion, when
aggregated with all other shares of common stock owned by DMRJ at such time,
would result in DMRJ beneficially owning in excess of 4.99% of the then issued
and outstanding shares of common stock. DMRJ may waive such limitation by
providing us with 61 days’ prior written notice.
As of
December 31, 2009, our obligations to DMRJ under the amended and restated senior
secured promissory note, the second senior secured promissory note and under the
credit facility approximated $4,480,000, $1,000,000 and $1,819,000,
respectively. Further, as of December 31, 2009, our obligation to
DMRJ for accrued interest under the amended senior secured promissory notes and
under the credit facility approximated $282,000. All such amounts were due and
payable on December 31, 2009.
On
January 12, 2010, we entered into an omnibus waiver and first amendment to
credit agreement and third amendment to note and warrant purchase agreement with
DMRJ pursuant to which: (i) our line of credit under the September 2009 credit
agreement was increased from $3,000,000 to $5,000,000; (ii) the maturity of all
of our indebtedness to DMRJ, including indebtedness under (a) the March 2009
amended and restated promissory note, (b) the July 2009 promissory note and (c)
the September 2009 revolving promissory note, was extended from December 10,
2009 to June 10, 2010; (iii) DMRJ waived all existing defaults under all of
these promissory notes and all related credit agreements through the new
maturity date of June 10, 2010; (iv) the interest rate payable on our
obligations under each of the promissory notes was reduced to 15% per annum; (v)
all arrangements pursuant to which we were to share with DMRJ any profits
resulting from certain transactions was removed from the credit documents; (vi)
we agreed to certain limitations on equity financings without DMRJ’s prior
consent; and (vii) we agreed that we will not prepay more than $3,600,000 of the
$5,600,000 of indebtedness owed to DMRJ under the March 2009 amended and
restated promissory note without DMRJ’s prior consent.
The
failure to refinance this indebtedness or otherwise negotiate extensions of our
obligations to DMRJ would have a material adverse impact on our liquidity and
financial condition and could force us to curtail or discontinue operations
entirely and/or
file for protection under bankruptcy laws.
-41-
Our
ability to comply with our debt covenants in the future depends on our ability
to generate sufficient sales and to control expenses, and will require us to
seek additional capital through private financing sources. There can
be no assurances that we will achieve our forecasted financial results or that
we will be able to raise additional capital to operate our
business. Any such failure would have a material adverse impact on
our liquidity and financial condition and could force us to curtail or
discontinue operations entirely and/or file for protection under bankruptcy
laws. Further, upon the occurrence of an event of default under
certain provisions of our agreements with DMRJ, we could be required to pay
default rate interest equal to the lesser of 3.0% per month and the maximum
applicable legal rate per annum on the outstanding principal balance
outstanding.
We are
currently expending significant resources to develop the next generation of our
current products and to develop new products. Although we continue to
fund as much research and development as possible through government grants and
contracts in accordance with the provisions of the respective grant awards, we
will require additional funding in order to continue the advancement of the
commercial development and manufacturing of the explosives detection
system. We will attempt to obtain such financing by: (i) government
grants, (ii) private financing, or (iii) strategic
partnerships. However, there can be no assurance that we will be
successful in our attempts to raise such additional financing.
We will
require substantial funds for further research and development, regulatory
approvals, and the marketing of our explosives detection
products. Our capital requirements depend on numerous factors,
including but not limited to the progress of our research and development
programs; the cost of filing, prosecuting, defending and enforcing any
intellectual property rights; competing technological and market developments;
changes in our development of commercialization activities and arrangements; the
hiring of additional personnel; and acquiring capital equipment.
Based on
the current sales, expense and cash flow projections, advances on our line of
credit, proceeds from certain expected sales of assets, and the ability to raise
additional capital, management believes it has plans in place to fund operations
through June 10, 2010 and, if we are successful in refinancing our obligations
to DMRJ, for the near future. If we are successful in refinancing
these obligations, there can still be no assurances that sales will materialize
as forecasted, management will be successful in executing its business plan,
and/or any capital we raise will be sufficient to fund operations indefinitely.
Management will therefore continue to closely monitor and attempt to control our
costs and will continue to actively seek the needed capital through government
grants and awards, strategic alliances, private financing sources, and through
our lending institutions. Future expenditures for research and
product development are discretionary and can be adjusted, as can certain
selling, general and administrative expenses, based on the availability of
cash. The financial statements do not include any adjustments
relating to the recoverability and classification of asset amounts or the
amounts and classification of liabilities that might be necessary should we be
unable to continue as a going concern.
Off-Balance
Sheet Arrangements
As of
December 31, 2009 we had an irrevocable standby letter of credit outstanding in
the approximate amount of $418,000. The letter of credit provides
performance security equal to 10% of the contract amount for product shipped in
the first quarter of fiscal 2009. The letter of credit expires on
July 31, 2010.
As of
December 31, 2009, we did not have any other off-balance sheet arrangements that
have, or are reasonably likely to have, a current or future material effect on
our condensed consolidated financial condition, results of operations,
liquidity, capital expenditures or capital resources.
-42-
New
Accounting Pronouncements
In June
2009, the Financial Accounting Standards Board (“FASB”) issued Statement of
Financial Accounting Standards No. 168, “The FASB Accounting Standards
Codification and the
Hierarchy of Generally Accepted Accounting Principles (“GAAP”)”, a replacement of FASB Statement No.
162 (“SFAS 168”). SFAS 168 establishes the FASB Accounting Standards
Codification as the single source of authoritative generally accepted accounting
principles in the United States, other than rules and interpretive releases
issued by the Securities and Exchange Commission. The Codification is a
reorganization of current GAAP into a topical format that eliminates the current
GAAP hierarchy and establishes instead two levels of guidance — authoritative
and nonauthoritative. All non-grandfathered, non-SEC accounting literature that
is not included in the Codification will become nonauthoritative. The FASB’s
primary goal in developing the Codification is to simplify user access to all
authoritative GAAP by providing all the authoritative literature related to a
particular accounting topic in one place. The Codification is effective for
interim and annual periods ending after September 15, 2009. Following SFAS
168, the FASB will not issue new standards in the form of Statements, FASB Staff
Positions, or Emerging Issue Task Force Abstracts; instead, it will issue
Accounting Standards Updates. The FASB will not consider Accounting Standards
Updates as authoritative in their own right; these updates will serve only to
update the Codification, provide background information about the guidance, and
provide the bases for conclusions on the change(s) in the Codification. In
the description of Accounting Standards Updates that follows, references in
“italics” relate to Codification Topics and Subtopics, and their descriptive
titles, as appropriate.
Accounting
Standards Updates—In June 2009, an update was made to “Consolidation — Consolidation
of Variable Interest Entities” Among other things, the update
replaces the calculation for determining which entities, if any, have a
controlling financial interest in a variable interest entity (VIE) from a
quantitative-based risks and rewards calculation, to a qualitative approach that
focuses on identifying which entities have the power to direct the activities
that most significantly impact the VIE’s economic performance and the obligation
to absorb losses of the VIE or the right to receive benefits from the VIE. The
update also requires ongoing assessments as to whether an entity is the primary
beneficiary of a VIE (previously, reconsideration was only required upon the
occurrence of specific events), modifies the presentation of consolidated VIE
assets and liabilities, and requires additional disclosures about a company’s
involvement in VIEs. This update will be effective for fiscal years beginning
after November 15, 2009. We do not currently believe that the adoption of
this update will have any effect on our consolidated financial position and
results of operations.
In
September 2009, an update was made to “Fair Value Measurements and
Disclosures — Investments in Certain Entities that Calculate Net Asset
Value per Share (or Its Equivalent).” This update permits entities
to measure the fair value of certain investments, including those with fair
values that are not readily determinable, on the basis of the net asset value
per share of the investment (or its equivalent) if such net asset value is
calculated in a manner consistent with the measurement principles in “Financial Services-Investment
Companies” as of the reporting entity’s measurement date (measurement of
all or substantially all of the underlying investments of the investee in
accordance with the “Fair
Value Measurements and Disclosures” guidance). The update also requires
enhanced disclosures about the nature and risks of investments within its scope
that are measured at fair value on a recurring or nonrecurring basis. This
update will be effective for interim and annual periods ending after
December 15, 2009. We are currently evaluating the effect that adoption of
this update will have, if any, on our consolidated financial position and
results of operations.
In
October 2009, an update was made to “Revenue Recognition —
Multiple Deliverable Revenue Arrangements.” This update removes the
objective-and-reliable-evidence-of-fair-value criterion from the separation
criteria used to determine whether an arrangement involving multiple
deliverables contains more than one unit of accounting, replaces references to
“fair value” with “selling price” to distinguish from the fair value
measurements required under the “Fair Value Measurements and
Disclosures” guidance, provides a hierarchy that entities must use to
estimate the selling price, eliminates the use of the residual method for
allocation, and expands the ongoing disclosure requirements. This update is
effective for fiscal years beginning on or after June 15, 2010, and can be
applied prospectively or retrospectively. We are currently evaluating the effect
that adoption of this update will have, if any, on our consolidated financial
position and results of operations.
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Not
required pursuant to Item 305(e) of Regulation S-K.
The
certifications of our Chief Executive Officer and Chief Financial Officer
attached as Exhibits 31.1 and 31.2 to this Annual Report on Form 10-Q include,
in paragraph 4 of such certifications, information concerning our disclosure
controls and procedures, and internal control over financial
reporting. Such certifications should be read in conjunction with the
information contained in this Item 4 for a more complete understanding of the
matters covered by such certifications.
Disclosure
Controls and Procedures
Our
management, with the participation of our Chief Executive Officer and Chief
Financial Officer, evaluated the effectiveness of our disclosure controls and
procedures as of December 31, 2009. The term “disclosure controls and
procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Securities
Exchange Act of 1934, means controls and other procedures of a company that are
designed to ensure that information required to be disclosed by the company in
the reports that it files or submits under the Exchange Act is recorded,
processed, summarized, and reported, within the time periods specified in the
rules and forms of the Securities and Exchange Commission. Disclosure
controls and procedures include, without limitation, controls and procedures
designed to ensure that information required to be disclosed by a company in the
reports that it files or submits under the Exchange Act is accumulated and
communicated to the company’s management, including its Chief Executive Officer
and Chief Financial Officer, as appropriate, to allow timely decisions to be
made regarding required disclosure. It should be noted that any
system of controls and procedures, however well designed and operated, can
provide only reasonable, and not absolute, assurance that the objectives of the
system are met and that management necessarily applies its judgment in
evaluating the cost-benefit relationship of possible controls and
procedures. Based on the evaluation of our disclosure controls and
procedures as of December 31, 2009, our Chief Executive Officer and Chief
Financial Officer concluded that, as of such date, our disclosure controls and
procedures were effective at the reasonable assurance level.
Changes
in Internal Control Over Financial Reporting
There
were no changes to our internal control over financial reporting during the
quarter ended December 31, 2009 that have materially affected, or are reasonably
likely to materially affect, our internal control over financial
reporting.
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PART
II. OTHER
INFORMATION
From time
to time, we are subject to various claims, legal proceedings and investigations
covering a wide range of matters that arise in the ordinary course of our
business activities. Each of these matters is subject to various
uncertainties.
In
conjunction with the May 2007 sale of our Accurel business to Evans Analytical,
Accurel entered into a sublease of its facility to Evans. In April
2009, Silicon Valley CA-I, LLC, the lessor of such property to Accurel, filed
suit against Accurel and Evans in the Superior Court of the State of California,
County of Santa Clara, alleging nonpayment of rent. On June 24, 2009, Accurel
and Evans entered into a release and settlement agreement with the lessor, under
the terms of which Accurel was required to pay $224,840, representing the
amounts that are past due under the lease, plus monthly rents owing under the
lease, less the payment that Evans is required to make under the terms of the
settlement agreement. Accurel was required to pay such amount on or
before September 4, 2009. On September 4, 2009, Accurel remitted the settlement
payment. In accordance with the release and settlement agreement,
provided that Accurel and Evans have complied with the terms of the lease and
payment in accordance with the agreement, the lessor has agreed to dismiss the
suit on or before September 14, 2009, and Accurel will have no further
obligations or liabilities to the lessor. On October 28, 2009, the
request for dismissal was entered with the Superior Court of the State of
California, County of Santa Clara.
Except as
disclosed under Item 3 of our Annual Report on Form 10-K, as amended, for the
fiscal year ended June 30, 2009, we are not a party to any other legal
proceedings, other than ordinary routine litigation incidental to our business,
which we believe will not have a material affect on our business, assets or
results of operations.
Item
1A.
|
Risk
Factors
|
Other than as set forth below,
there have not been any material changes from the risk factors previously
disclosed under Item 1A of our Annual Report on Form 10-K, as amended, for the
fiscal year ended June 30, 2009.
We
will be required to repay our borrowings from DMRJ Group LLC on June 10,
2010.
We will
be required to repay all of our borrowings from DMRJ Group LLC on June 10,
2010. Our obligations to DMRJ are secured by a security interest in
substantially all of our assets. As of December 31, 2009, the
outstanding balance due to DMRJ under two senior secured promissory notes and a
revolving credit facility were $4,480,000, $1,000,000 and $1,819,000,
respectively. If we are unable to repay these amounts as required,
refinance our obligations to DMRJ, or negotiate extensions of these obligations,
DMRJ may seize our assets and we may be forced to curtail or discontinue
operations entirely and/or file for protection under bankruptcy
laws.
We
will require additional capital to fund operations and continue the development,
commercialization and marketing of our product. Our failure to raise
capital could have a material adverse effect on the business.
Management
continually evaluates plans to reduce our operating expenses, increase sales and
increase our cash flow from operations. Despite our current sales,
expense and cash flow projections, we will require additional capital in the
fourth quarter of fiscal 2010 to fund operations and continue the development,
commercialization and marketing of our products. Our failure to achieve our
projections and/or obtain sufficient additional capital on acceptable terms
would have a material adverse effect on our liquidity and operations and could
require us to file for protection under bankruptcy laws.
Item
2.
|
Unregistered
Sales of Equity Securities and Use of
Proceeds
|
On October
21, 2009, we agreed to issue 500,000 shares of common stock, having a value of
$99,000, to Secure Strategy Group, LLC, in consideration of services rendered
and to be rendered in connection the with our efforts to secure additional
funding of which 300,000 vested immediately and the balance of which will vest
in equal monthly installments of 33,333 commencing on October 31,
2009.
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On
October 21, 2009, we agreed to issue 200,000 shares of common stock, having a
value of $47,000, to JFS Investments, Inc., in consideration of services
rendered and to be rendered in connection the with our efforts to secure
additional funding of which 100,000 vested immediately and the balance of which
will vest in equal monthly installments of 8,333 commencing on October 31,
2009.
The
issuances of these securities to Secret Strategy Group and to JFS Investments
are exempt from registration under the Securities Act of 1933, as amended,
pursuant to an exemption provided by Section 4(2) of the Securities
Act.
Also on
December 31, 2009, DMRJ Group, LLC elected to convert $120,000 of the principal
amount owed by us under one of the promissory notes into 1,500,000 shares of our
common stock, at an adjusted conversion price of $.08 per share.
The
issuance of these securities to DMRJ is exempt from registration under the
Securities Act pursuant to an exemption provided by Section 3(a)(9) of the
Securities Act.
Item
3.
|
Defaults
Upon Senior Securities
|
Item
4.
|
Submission
of Matters to a Vote of Security
Holders
|
None.
None.
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Item
6.
|
Exhibits
|
Exhibit
No.
|
Omnibus
Waiver and First Amendment to Credit Agreement and Third Amendment to Note
and Warrant Purchase Agreement, dated as of January 12, 2010 between
Implant Sciences Corporation and DMRJ Group
LLC
|
|
10.2
(1)
|
Amended
and Restated Promissory Note, dated as of January 12,
2010
|
|
31.1
(2)
|
Certification
of Principal Executive Officer pursuant to Section 3.02 of the
Sarbanes-Oxley Act of 2002.
|
|
31.2
(2)
|
Certification
of Principal Financial Officer pursuant to Section 3.02 of the
Sarbanes-Oxley Act of 2002.
|
|
32.1
(2)
|
Certification
of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
|
|
32.2
(2)
|
Certification
of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
|
|
______________________
|
(1)
|
Filed
as an Exhibit to Implant Sciences Corporation’s Form 8-K dated January 13,
2010 and filed January 14, 2010.
|
(2)
|
Filed
herewith.
|
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SIGNATURES
Pursuant
to the requirements of the Securities Exchange Act of 1934, the registrant has
duly caused this report to be signed on our behalf by the undersigned thereunto
duly authorized.
Implant
Sciences Corporation
By: /s/ Glenn D.
Bolduc
Glenn D.
Bolduc
President,
Chief Executive Officer and Chief Financial Officer
Dated: February
22, 2010
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