Attached files
file | filename |
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EX-32.2 - DERMA SCIENCES, INC. | v184066_ex32-2.htm |
EX-32.1 - DERMA SCIENCES, INC. | v184066_ex32-1.htm |
EX-31.2 - DERMA SCIENCES, INC. | v184066_ex31-2.htm |
EX-31.1 - DERMA SCIENCES, INC. | v184066_ex31-1.htm |
UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington,
DC 20549
___________________
FORM
10-Q
(Mark
One)
x
|
QUARTERLY
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITES EXCHANGE ACT OF
1934
|
For
the quarterly period ended March 31,
2010
|
¨
|
TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
|
For
the transition period from ____________ to ____________
|
|
Commission
file number
1-31070
|
Derma
Sciences, Inc.
(Exact
name of registrant as specified in its charter)
Pennsylvania
|
23-2328753
|
|
(State
or other jurisdiction of Incorporation)
|
(IRS
employer identification number)
|
214
Carnegie Center, Suite 300
Princeton,
NJ 08540
(Address
of principal executive offices)
(609)
514-4744
(Issuer’s
telephone number)
Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days.
Yes x No ¨
Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding
12 months (or for such shorter period that the registrant was required to submit
and post such files).
Yes ¨ No ¨
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting
company. See the definitions of “large accelerated filer,”
“accelerated filer” and “smaller reporting company” in Rule 12b-2 of the
Exchange Act.
Large
accelerated filer
|
¨
|
Accelerated
filer
|
¨
|
|
Non-accelerated
filer
|
¨ (Do
not check if a smaller reporting company)
|
Smaller
reporting company
|
x
|
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act).
Yes ¨ No
x
Indicate
the number of shares outstanding of each of the issuer's classes of common
stock, as of the latest practicable date.
Date: May
12, 2010
|
Class:
|
Common
Stock, par value $.01 per share
|
Shares
Outstanding: 6,557,855
|
PART
I – FINANCIAL INFORMATION
DERMA
SCIENCES, INC.
FORM
10-Q
INDEX
Description
|
Page
|
||
Part
I – Financial Information
|
|||
Item
1. Financial Statements
|
|||
Condensed
Consolidated Balance Sheets – March 31, 2010 (Unaudited)
and
|
|||
December
31, 2009
|
3
|
||
Condensed
Consolidated Statements of Operations – Three months ended
|
|||
March
31, 2010 and March 31, 2009 (Unaudited)
|
4
|
||
Condensed
Consolidated Statements of Cash Flows – Three months ended
|
|||
March
31, 2010 and March 31, 2009 (Unaudited)
|
5
|
||
Notes
to Condensed Consolidated Financial Statements (Unaudited)
|
6
|
||
Item
2. Management’s Discussion and Analysis of Financial
Condition
|
|||
and
Results of Operations
|
14
|
||
Item
4. Controls and Procedures
|
22
|
||
Part
II - Other Information
|
|||
Item
1A. Risk Factors
|
23
|
||
Item
6. Exhibits
|
24
|
Forward Looking
Statements
This
document includes certain “forward-looking statements” within the meaning of the
Private Securities Litigation Reform Act of 1995. These statements
are based on management’s current expectations and are subject to uncertainty
and changes in circumstances. Actual results may differ materially
from these expectations due to changes in political, economic, business,
competitive, market and regulatory factors.
1
Part
I – Financial Information
Item
1. FINANCIAL STATEMENTS
2
DERMA
SCIENCES, INC. AND SUBSIDIARIES
Condensed
Consolidated Balance Sheets
|
March 31,
2010
(Unaudited)
|
December 31,
2009
|
||||||
ASSETS
|
||||||||
Current
Assets
|
||||||||
Cash
and cash equivalents
|
$ | 812,602 | $ | 243,524 | ||||
Accounts
receivable, net
|
3,548,470 | 3,372,712 | ||||||
Inventories
|
13,226,445 | 11,489,724 | ||||||
Prepaid
expenses and other current assets
|
452,978 | 456,675 | ||||||
Total
current assets
|
18,040,495 | 15,562,635 | ||||||
Cash
– restricted
|
- | 2,032,164 | ||||||
Equipment
and improvements, net
|
3,625,974 | 3,741,347 | ||||||
Goodwill
|
7,119,726 | 7,119,726 | ||||||
Other
intangible assets, net
|
8,139,250 | 3,994,250 | ||||||
Other
assets, net
|
393,222 | 849,753 | ||||||
Total
Assets
|
$ | 37,318,667 | $ | 33,299,875 | ||||
LIABILITIES
AND SHAREHOLDERS’ EQUITY
|
||||||||
Current
Liabilities
|
||||||||
Line
of credit borrowings
|
2,425,600 | 2,306,306 | ||||||
Current
maturities of long-term debt
|
41,670 | 1,759,185 | ||||||
Accounts
payable
|
3,817,357 | 3,363,096 | ||||||
Accrued
expenses and other current liabilities
|
2,259,804 | 1,342,467 | ||||||
Total
current liabilities
|
8,544,431 | 8,771,054 | ||||||
Long-term
debt
|
- | 2,305,851 | ||||||
Other
long-term liabilities
|
88,898 | 96,564 | ||||||
Deferred
tax liability
|
336,695 | 355,349 | ||||||
Total
Liabilities
|
8,970,024 | 11,528,818 | ||||||
Shareholders’
Equity
|
||||||||
Convertible
preferred stock, $.01 par value; 1,468,750 shares authorized; issued and
outstanding: 285,064 shares (liquidation preference of $4,209,474 at March
31, 2010)
|
2,851 | 2,851 | ||||||
Common
stock, $.01 par value; 18,750,000 authorized; issued and outstanding:
6,557,855 at March 31, 2010; 5,039,468 at December 31,
2009
|
65,579 | 50,395 | ||||||
Additional
paid-in capital
|
48,142,646 | 41,221,613 | ||||||
Accumulated
other comprehensive income – cumulative translation
adjustments
|
1,479,566 | 1,303,293 | ||||||
Accumulated
deficit
|
(21,341,999 | ) | (20,807,095 | ) | ||||
Total
Shareholders’ Equity
|
28,348,643 | 21,771,057 | ||||||
Total
Liabilities and Shareholders’ Equity
|
$ | 37,318,667 | $ | 33,299,875 |
See
accompanying consolidated notes.
3
DERMA
SCIENCES, INC. AND SUBSIDIARIES
Condensed
Consolidated Statements of Operations (Unaudited)
Three Months ended March 31,
|
||||||||
2010
|
2009
|
|||||||
Net
Sales
|
$ | 12,844,382 | $ | 10,431,891 | ||||
Cost
of sales
|
8,818,982 | 7,078,255 | ||||||
Gross
Profit
|
4,025,400 | 3,353,636 | ||||||
Operating
Expenses
|
||||||||
Selling,
general and administrative
|
4,223,245 | 3,864,127 | ||||||
Research
and development
|
116,107 | 130,346 | ||||||
Total
operating expenses
|
4,339,352 | 3,994,473 | ||||||
Operating
loss
|
(313,952 | ) | (640,837 | ) | ||||
Other
expense, net:
|
||||||||
Interest
expense
|
159,892 | 171,470 | ||||||
Loss
on Debt Extinguishment
|
114,072 | - | ||||||
Other
income
|
(109,506 | ) | (1,536 | ) | ||||
Total
other expense
|
164,458 | 169,934 | ||||||
Loss
before provision for income taxes
|
(478,410 | ) | (810,771 | ) | ||||
Provision
(benefit) for income taxes
|
56,494 | (52,691 | ) | |||||
Net
Loss
|
$ | (534,904 | ) | $ | (758,080 | ) | ||
Net
loss per common share – basic and diluted
|
$ | (0.09 | ) | $ | (0.15 | ) | ||
Shares
used in computing net loss per common share – basic and
diluted
|
5,647,175 | 5,017,593 |
See
accompanying consolidated notes.
4
DERMA
SCIENCES, INC. AND SUBSIDIARIES
Condensed
Consolidated Statements of Cash Flows (Unaudited)
Three Months Ended March 31,
|
||||||||
2010
|
2009
|
|||||||
Operating
Activities
|
||||||||
Net
Loss
|
$ | (534,904 | ) | $ | (758,080 | ) | ||
Adjustments
to reconcile net loss to net cash provided by operating
activities:
|
||||||||
Depreciation
of equipment and improvements
|
241,796 | 208,246 | ||||||
Amortization
of intangible assets
|
364,000 | 330,380 | ||||||
Amortization
of deferred financing costs
|
32,678 | 36,405 | ||||||
Loss
on debt extinguishment
|
114,072 | - | ||||||
Recovery
of bad debts
|
(2,688 | ) | (27,576 | ) | ||||
Allowance
for sales adjustments
|
3,481 | 227,934 | ||||||
Provision
for inventory obsolescence
|
105,006 | 56,731 | ||||||
Deferred
rent expense
|
(5,211 | ) | (10,872 | ) | ||||
Compensation
charge for employee stock options
|
165,376 | 229,083 | ||||||
Compensation
charge for restricted stock
|
- | 12,105 | ||||||
Gain
on sale of equipment
|
- | (59,031 | ) | |||||
Deferred
income taxes
|
(30,025 | ) | (14,616 | ) | ||||
Changes
in operating assets and liabilities:
|
||||||||
Accounts
receivable
|
(176,552 | ) | 873,883 | |||||
Inventories
|
(1,693,834 | ) | 524,218 | |||||
Prepaid
expenses and other current assets
|
7,076 | (84,353 | ) | |||||
Other
assets
|
310,818 | (148 | ) | |||||
Accounts
payable
|
419,476 | (964,772 | ) | |||||
Accrued
expenses and other current liabilities
|
809,749 | (430,195 | ) | |||||
Other
long-term liabilities
|
(5,049 | ) | 5,335 | |||||
Net
cash provided by operating activities
|
125,265 | 154,677 | ||||||
Investing
Activities
|
||||||||
Purchase
of equipment and improvements
|
(42,927 | ) | (19,655 | ) | ||||
Purchase
of intangible asset
|
(2,250,000 | ) | - | |||||
Proceeds
from sale of equipment
|
- | 61,000 | ||||||
Net
cash (used in) provided by investing activities
|
(2,292,927 | ) | 41,345 | |||||
Financing
Activities
|
||||||||
Net
change in bank line of credit
|
119,294 | 87,508 | ||||||
Long-term
debt repayments
|
(4,023,365 | ) | (331,050 | ) | ||||
Net
change in restricted cash
|
2,032,164 | (6,312 | ) | |||||
Proceeds
from issuance of stock, net of costs
|
4,511,840 | - | ||||||
Net
cash provided by (used in) financing activities
|
2,639,933 | (249,854 | ) | |||||
Effect
of exchange rate changes on cash
|
96,807 | (48,601 | ) | |||||
Net
increase (decrease) in cash and cash equivalents
|
569,078 | (102,433 | ) | |||||
Cash
and cash equivalents
|
||||||||
Beginning
of period
|
243,524 | 391,038 | ||||||
End
of period
|
$ | 812,602 | $ | 288,605 | ||||
Supplemental
disclosures of cash flow information:
|
||||||||
Issuance
of common stock and warrants for purchase of intangible
asset
|
$ | 2,259,000 | $ | - | ||||
Cash
paid during the period for:
|
||||||||
Interest
|
$ | 142,225 | $ | 150,845 |
See
accompanying consolidated notes.
5
DERMA
SCIENCES, INC. AND SUBSIDIARIES
Notes to
Condensed Consolidated Financial Statements (Unaudited)
1.
|
Organization
and Summary of Significant Accounting
Policies
|
Derma
Sciences, Inc. and its subsidiaries (the “Company”) is a full line provider of
wound care, wound closure and specialty securement devices and skin care
products. The Company markets its products principally through
independent distributors servicing the long-term care, home health and acute
care markets in the United States, Canada and other select international
markets. The Company’s U.S. distribution facilities are located in
St. Louis, Missouri and Houston, Texas, while the Company’s Canadian
distribution facility is located in Toronto. The Company has
manufacturing facilities in Toronto, Canada and Nantong, China.
Basis of Presentation
The accompanying unaudited condensed
consolidated financial statements have been prepared in accordance with
accounting principles generally accepted in the United States of America for
interim financial information and with the instructions to Form 10-Q and Article
8 of Regulation S-X. Accordingly, they do not include all of the
information and footnotes required by accounting principles generally accepted
in the United States of America for complete financial statements. In
the opinion of management, all adjustments (consisting of normal recurring
adjustments) considered necessary for a fair presentation have been
included. Operating results for the three months ended March 31,
2010, are not necessarily indicative of the results that may be expected for the
year ending December 31, 2010. Information included in the condensed
balance sheet as of December 31, 2009 has been derived from the consolidated
financial statements and footnotes thereto for the year ended December 31, 2009,
included in Form 10-K previously filed with the Securities and Exchange
Commission. For further information, refer to that Form
10-K.
Reverse Stock Split – The
accompanying financial statements reflect a 1-for-8 reverse split of the
Company’s common and preferred stock approved by the board of directors and
stockholders of the Company and made effective by an amendment to the Company’s
articles of incorporation on February 1, 2010. All share and per
share information herein that relates to the Company’s common and preferred
stock has been retroactively restated to reflect the reverse stock
split.
Net Loss per Share – Net loss
per common share – basic is computed by dividing net loss by the weighted
average number of common shares outstanding for the period. Net loss
per common share – diluted reflects the potential dilution of earnings by
including the effects of the assumed exercise, conversion or issuance of
potentially issuable shares of common stock (“potentially dilutive securities”),
including those attributable to stock options, warrants, convertible preferred
stock and restricted common stock in the weighted average number of common
shares outstanding for a period, if dilutive. The effects of the
assumed exercise of warrants and stock options are determined using the treasury
stock method. Potentially dilutive securities have not been included
in the computation of diluted loss per share for the three months ended March
31, 2010 and 2009 as the effect would be anti-dilutive.
Potentially
dilutive shares excluded as a result of the effects being anti-dilutive are as
follows:
Three Months Ended March 31,
|
||||||||
2010
|
2009
|
|||||||
Dilutive
shares:
|
||||||||
Convertible
preferred stock
|
285,064 | 285,064 | ||||||
Restricted
common stock
|
- | 21,875 | ||||||
Warrants
|
1,734,531 | 1,099,438 | ||||||
Stock
options
|
1,168,350 | 1,084,453 | ||||||
Total
dilutive shares
|
3,187,945 | 2,490,830 |
6
DERMA
SCIENCES, INC. AND SUBSIDIARIES
Notes to
Condensed Consolidated Financial Statements (Unaudited)
2. Inventories
Inventories
include the following:
March 31,
2010
|
December 31,
2009
|
|||||||
Finished goods
|
$ | 9,081,167 | $ | 7,804,339 | ||||
Work
in process
|
544,829 | 466,365 | ||||||
Packaging
materials
|
868,818 | 722,148 | ||||||
Raw
materials
|
2,731,631 | 2,496,872 | ||||||
Total
inventory
|
$ | 13,226,445 | $ | 11,489,724 |
3. Line
of Credit Borrowings
In
November 2007, the Company entered into a five-year revolving credit agreement
providing for maximum borrowings of $8,000,000 with a U.S.
lender. The revolving credit agreement was amended from time to time,
the latest of which was March 26, 2010. Advances under the revolving
credit agreement, as amended may be drawn, up to 85% of eligible
receivables (as defined) and 44% of eligible inventory (as defined) less a
minimum excess availability reserve of $1,000,000. Interest on
outstanding advances under the amended revolving credit agreement is payable at
the three month LIBOR rate subject to a 1.50% floor plus 4.25%
. In addition, the Company pays a monthly unused line fee of
0.5% per annum on the difference between the daily average amount of advances
outstanding under the amended agreement and $8,000,000 together with a monthly
collateral management fee of $2,000. At March 31, 2010 the effective
interest rate was 5.75% and the outstanding balance was $2,425,600.
Outstanding
balances under the amended agreement are secured by all of the Company’s and its
subsidiaries’ existing and after-acquired tangible and intangible assets located
in the United States and Canada.
The
revolving credit agreement, as amended, is subject to financial covenants which
require maintaining a minimum of fixed charge coverage and total leverage ratios
(as defined). Additional covenants governing permitted investments,
indebtedness and liens, together with payments of dividends and protection of
collateral, are also included in the agreement. The amended revolving
credit agreement contains a subjective acceleration provision whereby the lender
can declare a default upon a material adverse change in the Company’s business
operations.
4.
|
Long-Term
Debt
|
Long-term debt consists of the
following:
March 31,
2010
|
December 31,
2009
|
|||||||
U.S. term loan
|
$ | - | $ | 3,500,000 | ||||
Promissory
note
|
- | 500,000 | ||||||
Capital
lease obligations
|
41,670 | 65,036 | ||||||
Total
debt
|
41,670 | 4,065,036 | ||||||
Less: current
maturities
|
41,670 | 1,759,185 | ||||||
Long-term
debt
|
$ | - | $ | 2,305,851 |
7
DERMA
SCIENCES, INC. AND SUBSIDIARIES
Notes to
Condensed Consolidated Financial Statements (Unaudited)
U.S. Term Loan
In
November 2007, the Company entered into a five-year $6,000,000 term loan
agreement with a U.S. lender. On February 23, 2010 the term loan was
paid off which resulted in a $114,072 loss on debt extinguishment.
Promissory Note
In connection with an April, 2006
acquisition a portion of the purchase price was paid via a
12% unsecured promissory note issued to the seller. The
promissory note provided for quarterly interest installments of
$15,000 and a final payment of the outstanding principal balance of $500,000
plus interest. The promissory note was paid off on March 31, 2010.
Capital Lease Obligations
The Company has two capital lease
obligations for certain office furniture totaling $41,670 as of March 31,
2010. The capital lease obligations bear interest at annual rates
ranging from 6.8% to 9.6% with the longest lease term expiring in February
2011.
5. Shareholders’
Equity
Preferred
Stock
There are
18,755 shares of series A convertible preferred stock outstanding at March 31,
2010. The series A preferred stock is convertible into common stock
on a one-for-one basis, bears no dividend, maintains a liquidation preference of
$32.00 per share, votes as a class on matters affecting the series A preferred
stock and maintains voting rights identical to the common stock on all other
matters.
There are
55,006 shares of series B convertible preferred stock outstanding at March 31,
2010. The series B preferred stock is convertible into common stock
on a one-for-one basis, bears no dividend, maintains a liquidation preference of
$48.00 per share, votes as a class on matters affecting the series B preferred
stock and maintains voting rights identical to the common stock on all other
matters.
There are 77,384 shares of series C
convertible preferred stock outstanding at March 31, 2010. The series
C preferred stock is convertible into common stock on a one-for-one basis, bears
no dividend, maintains a liquidation preference averaging $5.60 per share, votes
as a class on matters affecting the series C preferred stock and maintains
voting rights identical to the common stock on all other matters.
There are 133,919 shares of series D
convertible preferred stock outstanding at March 31, 2010. The series
D preferred stock is convertible into common stock on a one-for-one basis, bears
no dividend, maintains a liquidation preference averaging $4.00 per share, votes
as a class on matters affecting the series D preferred stock and maintains
voting rights identical to the common stock on all other matters.
Common
Stock
In
February 2010, the Company raised $4,511,840 (net of $1,077,160 in commission
and other offering expenses) from the sale of 1,117,800 shares of common stock
at a price of $5.00 per share, together with 372,600 five-year warrants to
purchase common stock at $5.50 per share. In addition, the placement
agent received 29,160 five-year warrants to purchase common stock at $6.25 per
share. A portion of the proceeds along with restricted cash of
$2,032,164 were used to acquire the perpetual worldwide Medihoney® licensing
rights from Comvita (Note 9) and pay off the outstanding U.S. term loan balance
of $3,300,000 and the $500,000 promissory note.
Also in
February 2010, the Company issued 400,000 shares of its common stock together
with 133,333 warrants to purchase its common stock at an exercise price of $5.50
per share and 100,000 warrants to purchase its common stock at an exercise price
of $6.25 per share in connection with the purchase of the world-wide Medihoney
license rights (see Note 9).
8
DERMA
SCIENCES, INC. AND SUBSIDIARIES
Notes to
Condensed Consolidated Financial Statements (Unaudited)
Effective
May 12, 2009, 21,875 shares of common stock were issued to outside directors
upon vesting of compensatory restricted stock granted on May 12,
2006.
Stock Purchase Warrants
At March 31, 2010, the Company had
warrants outstanding to purchase 1,734,531 shares of the Company’s common stock
as outlined below:
Series
|
Number of Warrants
|
Exercise Price
|
Expiration Date
|
||||||
H
|
331,915 | $ | 8.00 |
April
30,2011
|
|||||
I
|
94,351 | $ | 5.76 |
April
30, 2011
|
|||||
J
|
267,858 | $ | 6.16 |
May
31, 2013
|
|||||
K
|
399,064 | $ | 9.60 |
April
1, 2013
|
|||||
L
|
6,250 | $ | 3.12 |
March
31, 2014
|
|||||
N
|
100,000 | $ | 6.25 |
February
22, 2015
|
|||||
O
|
372,600 | $ | 5.50 |
February
22, 2015
|
|||||
P
|
29,160 | $ | 6.25 |
February
16, 2015
|
|||||
Q
|
133,333 | $ | 5.50 |
February
22, 2015
|
|||||
Total
|
1,734,531 |
|
Stock
Options
|
The
Company has a stock option plan under which options to purchase a maximum of
1,250,000 shares of common stock may be issued (“plan options”). The
plan permits the granting of both incentive stock options and nonqualified stock
options to employees and directors of the Company and certain outside
consultants and advisors to the Company. The option exercise price
may not be less than the fair market value of the stock on the date of the grant
of the option. The duration of each option may not exceed 10 years
from the date of grant. Plan options to purchase 102,000 and 112,500
shares of common stock were granted to officers, directors, agents and employees
for the three months ended March 31, 2010 and 2009, respectively, with exercise
prices ranging from $3.12 to $5.10 per share. For the three months
ended March 31, 2009, 1,250 plan options were forfeited. As of March
31, 2010, options to purchase 961,349 shares of the Company’s common stock were
issued and outstanding under the plan.
The
Company has previously granted nonqualified stock options to officers,
directors, agents and employees outside of the stock option plan (“non-plan
options”). All non-plan options were granted at the fair market value
at the date of grant. During the three months ended March 31,
2009, 29,625 non-plan options expired. As of March 31, 2010,
non-plan options to purchase 207,001 shares of the Company’s common stock were
issued and outstanding.
9
DERMA
SCIENCES, INC. AND SUBSIDIARIES
Notes to
Condensed Consolidated Financial Statements (Unaudited)
A summary
of the Company’s stock option activity and related information for the three
months ended March 31, 2010 and 2009 follows:
2010
|
2009
|
|||||||||||||||
Options
|
Weighted
Average
Exercise Price
|
Options
|
Weighted
Average
Exercise Price
|
|||||||||||||
Outstanding – January 1
|
1,066,350 | $ | 5.08 | 1,002,828 | $ | 5.52 | ||||||||||
Granted
|
102,000 | $ | 5.10 | 112,500 | $ | 3.12 | ||||||||||
Forfeited
|
- | (1,250 | ) | $ | 6.00 | |||||||||||
Expired
|
- | (29,625 | ) | $ | 8.88 | |||||||||||
Exercised
|
- | - | ||||||||||||||
Outstanding
– March 31
|
1,168,350 | $ | 5.08 | 1,084,453 | $ | 5.44 | ||||||||||
Exercisable
at March 31
|
970,778 | $ | 5.21 | 798,984 | $ | 5.20 |
During the three months ended March 31,
2010 and 2009 the fair value of each service and performance based option award
was estimated at the date of grant using the Black-Scholes option pricing
model. The weighted-average assumptions used during the three months
ended March 31, 2010 and 2009 were as follows:
Three Months Ended March 31,
|
||||||||
2010
|
2009
|
|||||||
Risk-free
interest rate
|
2.73 | % | 2.27 | % | ||||
Volatility
factor
|
79.9 | % | 94.3 | % | ||||
Dividend
yield
|
0 | % | 0 | % | ||||
Expected
option life (years)
|
6.25 | 6.25 | ||||||
Contractual
life (years)
|
10 | 10 |
In both
2010 and 2009, the risk-free rate utilized represents the U.S. Treasury yield
curve rate which approximates the risk-free rate for the expected option life at
the time of grant. In 2010 and 2009, the volatility factor was
calculated based on the seventy-five month-end closing prices of the Company’s
common stock preceding the month of stock option grant. The Company
uses a seventy-five month volatility period to coincide with the expected stock
option life. The dividend yield is 0% since the Company does not
anticipate paying dividends in the near future. Based on the
Company’s historical experience of options that expire or are cancelled before
becoming fully vested, the Company assumed an annualized forfeiture rate of 1.0%
for all options. The Company will record additional expense if the
actual forfeiture rate is lower than estimated, and will record a recovery of
prior expense if the actual forfeiture rate is higher than
estimated.
The weighted average fair value per
share of options granted during the three months ended March 31, 2010 and 2009
was $3.61 and $2.40, respectively. During the three months
ended March 31, 2010 and 2009, stock option compensation expense was recorded as
follows:
Three Months Ended March 31,
|
||||||||
2010
|
2009
|
|||||||
Cost
of sales
|
$ | 20,100 | $ | 27,110 | ||||
Selling,
general and administrative expenses
|
145,276 | 201,973 | ||||||
Total
stock option compensation expense
|
$ | 165,376 | $ | 229,083 |
10
DERMA
SCIENCES, INC. AND SUBSIDIARIES
Notes to
Condensed Consolidated Financial Statements (Unaudited)
As of
March 31, 2010, there was $485,429 of unrecognized compensation cost related to
nonvested service and $178,695 nonvested performance based
awards granted under the plan. These costs are expected to be
recognized over the options’ remaining weighted average vesting period of 1.54
years for the service and .75 years for the performance based
awards.
For the
three months ended March 31, 2010 and 2009, no income tax benefit was recognized
related to stock option activity.
Restricted
Common Stock
On May 11, 2006, the Company adopted a
restricted common stock plan and reserved 312,500 shares of common stock for
issuance.
On May 12, 2006, 21,875 shares of
restricted common stock were granted to non-employee members of the Company’s
board of directors and vested three years from the date of the
grant. The fair market value at the date of grant, determined by the
quoted market price, was $145,250 or $6.64 per share. The fair market
value of the grant was recognized as compensation expense over the three-year
service period. For the three months ended March 31, 2009,
$12,105 was recorded in operating expense respectively for these
grants.
Shares
Reserved for Future Issuance
At March 31, 2010, the Company had
reserved the following shares of common stock for future issuance:
Convertible
preferred shares (series A – D)
|
285,064 | |||
Common
stock options available for grant
|
288,651 | |||
Common
stock options outstanding
|
1,168,350 | |||
Common
stock warrants outstanding (series H – Q)
|
1,734,531 | |||
Restricted
common stock available for grant
|
290,625 | |||
Total common stock shares
reserved
|
3,767,221 |
6. Comprehensive
Loss
|
The
Company’s comprehensive loss was as
follows:
|
Three Months Ended
March 31,
|
||||||||
2010
|
2009
|
|||||||
Net
loss as reported
|
$ | (534,904 | ) | $ | (758,080 | ) | ||
Other comprehensive income (loss): | ||||||||
Foreign
currency translation adjustment
|
176,273 | (192,585 | ) | |||||
Comprehensive
loss
|
$ | (358,631 | ) | $ | (950,665 | ) |
7. Operating
Segments
The
Company consists of three operating segments: wound care, wound
closure – specialty securement devices and skin care. Products in the
wound care segment consist of basic and advanced dressings, adhesive strips,
ointments and sprays. Wound closure and specialty securement device
products include wound closure strips, nasal tube fasteners and a variety of
catheter fasteners. The skin care segment consists of antibacterial
skin cleansers, hair and body soaps, lotions and moisturizers.
11
DERMA
SCIENCES, INC. AND SUBSIDIARIES
Notes to
Condensed Consolidated Financial Statements (Unaudited)
Products
in all three operating segments are marketed to long-term care facilities,
hospitals, physicians, clinics, home health care agencies and other healthcare
institutions. Basic and advanced wound care products are manufactured
both internally and outsourced, while the manufacture of skin care products is
completely outsourced. Wound closure-specialty securement devices are
significantly manufactured in-house. Internally, the segments are
managed at the gross profit level. The aggregation or allocation of
other costs by segment is not practical.
Segment
sales, gross profit and other related information for 2010 and 2009 are as
follows:
Three Months Ended March 31, 2010
Wound Care
|
Wound Closure-
Specialty
Securement Devices
|
Skin Care
|
Other
|
Total
Company
|
||||||||||||||||
Net
sales
|
$ | 12,247,021 | $ | 473,471 | $ | 123,890 | - |
$ 12,844,382
|
||||||||||||
Gross
profit
|
3,728,964 | 265,800 | 30,636 | - |
4,025,400
|
|||||||||||||||
Total
expenses
|
- | - | - | $ | (4,560,304 | ) | (4,560,304 | ) | ||||||||||||
Net
loss
|
$ | (534,904 | ) | |||||||||||||||||
Three
Months Ended March 31, 2009
|
||||||||||||||||||||
Net
sales
|
$ | 9,799,483 | $ | 461,072 | $ | 171,336 | - | $ | 10,431,891 | |||||||||||
Gross
profit
|
3,060,653 | 246,188 | 46,795 | - | 3,353,636 | |||||||||||||||
Total
expenses
|
- | - | - | $ | (4,111,716 | ) | (4,111,716 | ) | ||||||||||||
Net
loss
|
$ | (758,080 | ) |
The following table presents net sales
by geographic region.
Three Months Ended
March 31,
|
||||||||
2010
|
2009
|
|||||||
United
States
|
68 | % | 73 | % | ||||
Canada
|
28 | % | 21 | % | ||||
Other
|
4 | % | 6 | % |
For the three months ended March 31,
2010, one U.S. customer was responsible for 13% of U.S. sales. The
Company’s wholly owned Canadian subsidiary sells to one customer who serves as
its exclusive third party distributor and comprises 100% of Canada operations
trade accounts receivable at March 31, 2010.
12
DERMA
SCIENCES, INC. AND SUBSIDIARIES
Notes to
Condensed Consolidated Financial Statements (Unaudited)
8.
|
Income
Taxes
|
The
Company recorded a $56,494 foreign income tax provision for the three months
ended March 31, 2010 and a $52,691 foreign income tax benefit for the three
months ended March 31, 2009 based on the operating results of the Company’s
wholly owned Canadian subsidiary. The 2010 provision was comprised of
$86,519 current foreign tax payable and $30,025 deferred foreign tax benefit
while the 2009 benefit was comprised of $38,075 current foreign tax and $14,616
deferred foreign tax benefits. No benefit was realized for the
Company’s net loss from U.S. operations in the three months ended March 31, 2010
and 2009 due to uncertainties surrounding the Company’s ability to utilize its
net operating loss carry forwards.
Due to
uncertainties surrounding the Company’s ability to use its U.S. net operating
loss carry forwards and net deferred assets, a full valuation allowance has been
provided. The Company’s wholly owned Canadian subsidiary, based on
recent operating profitability and the prospect of future profitable operations,
realized its net operating loss carry forward and deferred tax assets and
liabilities.
9.
|
Comvita
Licensing, Manufacturing and Sales
Agreement
|
On February 23, 2010, the
Company entered into various agreements with Comvita in which the Company
principally received perpetual and exclusive worldwide licensing rights for
Medihoney® professional wound and skin care products covering distribution and
sales to all markets outside of the consumer market. In connection
with the agreements the Company paid $2,250,000 and issued Comvita 400,000
shares of its common stock together with 133,333 warrants to purchase its common
stock at an exercise price of $5.50 per share and 100,000 warrants to
purchase its common stock at a price of $6.25 per share. The total
consideration paid to Comvita was valued at $4,509,000. The
$4,509,000 cost of the perpetual and worldwide licensing rights has been
recorded as an intangible asset and will be amortized over an estimated useful
life of 10 years.
The
agreement calls for royalty payments on all sales and additional payments to
Comvita if certain Medihoney® net sales milestones are achieved over the course
of the license. The license rights may be terminated or rendered non-exclusive
by Comvita if the Company fails to meet certain minimum royalty
requirements.
13
Item
2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Quarter
Ended March 31, 2010 Compared to Quarter Ended March 31, 2009
Overview
The
following table highlights the quarter ended March 31, 2010 versus 2009
operating results:
Quarter
Ended March 31,
|
Variance
|
|||||||||||||||
|
2010
|
2009
|
||||||||||||||
Gross
Sales
|
$ | 15,451,136 | $ | 12,601,759 | $ | 2,849,377 | 22.6 | % | ||||||||
Sales
adjustments
|
(2,606,754 | ) | (2,169,868 | ) | 436,886 | 20.1 | % | |||||||||
Net
sales
|
12,844,382 | 10,431,891 | 2,412,491 | 23.1 | % | |||||||||||
Cost
of sales
|
8,818,982 | 7,078,255 | 1,740,727 | 24.6 | % | |||||||||||
Gross
profit
|
4,025,400 | 3,353,636 | 671,764 | 20. 0 | % | |||||||||||
Selling,
general and administrative expense
|
4,223,245 | 3,864,127 | 359,118 | 9.3 | % | |||||||||||
Research
and development expense
|
116,107 | 130,346 | (14,239 | ) | (10.9 | )% | ||||||||||
Interest
expense
|
159,892 | 171,470 | (11,578 | ) | (6.8 | )% | ||||||||||
Loss
on debt extinguishment
|
114,072 | - | 114,072 | |||||||||||||
Other
income, net
|
(109,506 | ) | (1,536 | ) | (107,970 | ) | ||||||||||
Total
expenses
|
4,503,810 | 4,164,407 | 339,403 | 8.2 | % | |||||||||||
Loss
before income taxes
|
(478,410 | ) | (810,771 | ) | 332,361 | 41.0 | % | |||||||||
Provision
(benefit) for income taxes
|
56,494 | (52,691 | ) | 109,185 | ||||||||||||
Net
loss
|
$ | (534,904 | ) | $ | (758,080 | ) | $ | 223,176 | 29.4 | % |
Gross
to Net Sales Adjustments
Gross to
net sales adjustments comprise the following:
Quarter Ended March 31,
|
||||||||
|
2010
|
2009
|
||||||
Gross
Sales
|
$ | 15,451,136 | $ | 12,601,759 | ||||
Trade
rebates
|
(1,947,867 | ) | (1,509,291 | ) | ||||
Distributor
fees
|
(329,673 | ) | (206,739 | ) | ||||
Sales
incentives
|
(123,810 | ) | (157,825 | ) | ||||
Returns
and allowances
|
(97,154 | ) | (185,500 | ) | ||||
Cash
discounts
|
(108,250 | ) | (110,513 | ) | ||||
Total
adjustments
|
(2,606,754 | ) | (2,169,868 | ) | ||||
Net
sales
|
$ | 12,844,382 | $ | 10,431,891 |
Trade
rebates increased in 2010 versus 2009 due principally to higher Canadian sales
subject to rebate, partially offset by the discontinuation of a significant U.S.
private label customer rebate program effective November 1, 2009. The increase
in distribution fee expense is commensurate with the increase in Canadian net
sales upon which it is based. The decrease in sales incentive expense reflects a
reduction in the number of the traditional wound care and first aid products
sales incentive programs in 2010 versus 2009. The sales returns and allowances
decrease is principally due to the non-recurrence of higher first aid products
related returns in 2009. The decrease in cash discounts reflects lower U.S.
sales subject to cash discount.
14
Rebate
Reserve Roll Forward
A three
month roll forward of the trade rebate accruals at March 31, 2010 and 2009 is
outlined below:
Quarter
Ended March 31,
|
||||||||
|
2010
|
2009
|
||||||
Beginning
balance – January 1
|
$ | 2,493,232 | $ | 2,660,086 | ||||
Rebates
paid
|
(2,096,942 | ) | (1,496,027 | ) | ||||
Rebates
accrued
|
1,947,867 | 1,509,291 | ||||||
Ending
balance – March 31
|
$ | 2,344,157 | $ | 2,673,350 |
The
$149,075 decrease in the trade rebate reserve balance for the three months ended
March 31, 2010 reflects the decision of one significant U.S. private label
customer to discontinue its rebate program effective November 1, 2009 and the
subsequent payment of the outstanding balance due this customer in 2010,
partially offset by an increase in the Canadian reserve due to higher sales.
There has been no other discernable change in the nature of our business in 2010
as it relates to the accrual and subsequent payment of rebates.
Net
Sales and Gross Margin
The
following table highlights the March 31, 2010 versus 2009 product line net sales
and gross profit:
Quarter
Ended March 31,
|
Variance
|
|||||||||||||||
|
2010
|
2009
|
||||||||||||||
Net
Sales
|
$
|
12,844,382
|
$
|
10,431,891
|
$
|
2,412,491
|
|
23.1%
|
||||||||
Cost
of sales
|
8,818,982
|
7,078,255
|
1,740,727
|
|
24.6%
|
|||||||||||
Gross
Profit
|
$
|
4,025,400
|
$
|
3,353,636
|
$
|
671,764
|
20.0%
|
|
||||||||
Gross
Profit %
|
31.3
|
%
|
32.1
|
%
|
Consolidated
net sales increased $2,412,491, or 23.1% (19.0% adjusted for exchange), in 2010
versus 2009. Canadian net sales increased $1,345,370, or 61.0%, to $3,550,775 in
2010 from $2,205,405 in 2009. This increase was driven by favorable exchange of
$433,334 associated with a 16.4% strengthening of the Canadian dollar, coupled
with sales growth of $912,036. The sales growth reflects the impact of inventory
rationalization on the part of our exclusive Canadian distributor of $696,454
together with $215,582 attributable to intrinsic growth. Real growth as measured
by sales of our Company’s products reported by our exclusive distributor,
unadjusted for foreign exchange, approximated 6.1%. U.S. net sales increased
$946,399, or 11.5%, to $9,172,885 in 2010 from $8,226,486 in 2009. The increase
was principally driven by higher advanced wound care sales of $727,098, or
54.9%, and first aid product sales of $219,084, or 7.4%. The balance of U.S.
sales consisting of traditional wound care, private label, specialty fixation,
burn care and skin care and bathing sales were flat period to period. The higher
advanced wound care sales reflect continued growth of our new products in
response to our expanded sales and marketing efforts. The increase in first aid
products sales reflects new business and improving demand. Sales of $120,722
associated with our recently initiated international growth strategy also
contributed.
Consolidated
gross profit increased $671,764, or 20.0%, in 2010 versus 2009. The consolidated
gross profit margin percentage decreased to 31.3% in 2010 from 32.1% in 2009.
The change in gross profit dollars reflects the higher sales, partially offset
by the lower gross profit margin percentage. The lower gross margin profit
percentage reflects unfavorable mix associated with the increase in lower
margined Canadian sales coupled with increasing product costs, unfavorable
exchange and higher obsolescence and transportation expense.
15
Selling,
General and Administrative Expenses
The
following table highlights March 31, 2010 versus 2009 selling, general and
administrative expenses by type:
Quarter
Ended March 31,
|
Variance
|
|||||||||||||||
|
2010
|
2009
|
||||||||||||||
Distribution
|
$ | 451,426 | $ | 427,734 | $ | 23,692 | 5.5 | % | ||||||||
Marketing
|
328,082 | 390,932 | (62,850 | ) | (16.1 | )% | ||||||||||
Sales
|
1,458,427 | 1,215,041 | 243,386 | 20.0 | % | |||||||||||
General
and administrative
|
1,985,310 | 1,830,420 | 154,890 | 8.5 | % | |||||||||||
Total
|
$ | 4,223,245 | $ | 3,864,127 | $ | 359,118 | 9.3 | % |
Selling,
general and administrative expenses increased $359,118, or 9.3% (6.2% adjusted
for exchange), in 2010 versus 2009, including an increase of $121,555 in
Canadian selling, general and administrative expenses attributable to
exchange.
Distribution
expense increased $23,692, or 5.5% (2.0% adjusted for exchange), in 2010 versus
2009, including an increase of $11,009 due to exchange. This increase reflects
inflation related expense increases and higher U. S. lease expenses, partially
offset by lower labor requirements in the Houston distribution center and lower
utilities due to a warmer average temperature in 2010.
Marketing
expense decreased $62,850, or 16.1% (17.7% adjusted for exchange), in 2010
versus 2009, including an increase of $6,316 due to exchange. The decrease is
attributable to lower U.S. and Canadian spending and timing.
General
and administrative expense increased $154,890, or 8.5% (2.1% adjusted for
exchange), in 2010 versus 2009. Expenses in Canada increased $72,962 (including
a $75,383 increase related to exchange). Net of exchange, expenses were down
with no significant change in the underlying expense base. Expenses in the U. S.
increased $39,980. This increase reflects higher planned investor relations
expenses of $35,417designed to increase investor awareness and improve our
stock’s trading volume, incremental amortization expense of $34,787 associated
with the Worldwide Medihoney License Agreement and bad debt expense of $21,989
partially offset by lower equity based compensation expense of approximately
$43,000 and other lower operating expenses. Incremental international expenses
of $41,948 associated with the start up of our international growth initiative
also contributed.
Research
and Development Expense
Research
and development expense decreased $14,239 to $116,107 in 2010 from $130,346 in
2009. The decrease principally reflects the timing of ongoing project
management, data management and patent related legal expenses.
16
Interest
Expense
Interest
expense decreased $11,578 to $159,892 in 2010 from $171,470 in 2009. The
decrease is principally attributable to lower loan related fees and lower
borrowing levels, partially offset by higher interest due to higher interest
rates.
Loss
on Extinguishment of Debt
In
connection with the payoff of our term loan in February 2010, we took a charge
of $114,072 representing that portion of the unamortized deferred financing
costs relating to the term loan.
Other
Income
Other
income increased $107,970 to $109,506 in 2010 from $1,536 in 2009. The main
drivers for the net year-to-year increase was an exchange gain of $172,554 (2010
income of $92,636 versus a 2009 loss of $79,918), partially offset by the
non-recurrence of approximately $60,000 of gains on miscellaneous asset sales
principally associated with the closure of the first aid product manufacturing
operation.
Income
Taxes
We
recorded a $56,494 foreign income tax provision for 2010 consisting of a $86,519
current foreign tax provision and a $30,025 deferred foreign tax benefit based
on our Canadian subsidiary’s operating results. No tax benefit was recorded for
our U.S. operations in 2010 or 2009 due to uncertainty surrounding our ability
to use available net operating loss carry forwards and net deferred tax
assets. In 2009, we recorded a $52,691 foreign income tax benefit
consisting of a $38,075 current tax benefit and a $14,616 deferred foreign tax
benefit based on our Canadian subsidiary’s operating results.
Due to
uncertainties surrounding our ability to use our U.S. net operating loss carry
forwards and net deferred tax assets, a full valuation allowance for the U.S.
net deferred tax assets has been provided.
Net
Loss
We
generated a net loss of $534,904, or $0.09 per share (basic and diluted), in
2010 compared to a net loss of $758,080, or $0.15 per share (basic and diluted),
in 2009.
Liquidity and Capital
Resources
Cash
Flow and Working Capital
At
March 31, 2010 and December 31, 2009, we had cash and cash equivalents on hand
of $812,602 and $243,524, respectively. The $569,078 increase in cash reflects
net cash provided by operating activities of $125,265 and financing activities
of $2,639,933, together with cash provided as a result of exchange rate changes
of $96,807. These increases were essentially offset by cash used in investing
activities of $2,292,927.
Net cash
provided by operating activities of $125,265 stems from $453,581 cash provided
from operations (net loss plus non-cash items), together with $328,316 cash used
from the net change in operating assets and liabilities. The increase in cash
provided from operations reflects the non-cash items, partially offset by the
operating loss. Higher inventory, offset by accounts payable and accrued
liabilities, were the main drivers behind the net cash used in connection with
the change in operating assets and liabilities. The increase in inventory
reflects a build up to support new products, anticipated growth of the
international business and to improve customer service levels in certain
segments of our business. The increase in accounts payable reflects an increase
in payables related to inventory purchases, higher overall spending levels and
timing. The increase in accrued expenses and other current liabilities
principally reflects higher Canadian rebates due to higher sales, the recording
of a severance accrual and timing related changes.
17
Net cash
used in investing activities of $2,292,927 reflects $2,250,000 cash used to
purchase the worldwide Medihoney license rights and capital expenditures of
$42,927.
Net cash
used in financing activities of $2,639,933 reflects net proceeds of $4,511,840
from the sale of stock in connection with a secondary public offering completed
in February, removal of the restriction on the use of $2,032,164 in cash and
$119,294 from an increase in the amount drawn against our line of credit.
Offsetting these increases were $4,023,365 in debt payments consisting of
regularly scheduled debt repayments, together with the full payment of the
balances of our term loan and our promissory note.
Working
capital increased $2,704,483 at March 31, 2010 to $9,496,064 from $6,791,581 at
December 31, 2009. This increase principally reflects the cash infusion
associated with the equity raise completed in February, a portion of the
proceeds of which were used to pay off short term debt of $1,700,000, and the
net balance of $494,658 that was used for general working capital purposes.
Working capital of this magnitude is considered sufficient to support ongoing
operations.
Based on
current forecasts, there are no Medihoney sales related milestone payments
anticipated in the next twelve months.
Financing
Arrangements
With cash
on hand of $812,602, together with available cash under our line of credit of
$2,998,988, we have $3,811,590 of available liquidity at March 31, 2009, versus
$2,342,579 at December 31, 2009.
On
February 22, 2010, we raised $4,511,840 (net of commission and other offering
expenses) from the sale in a secondary public offering of shares of our common
stock. These proceeds, together with $2,032,818 of previously restricted cash,
were used to acquire the worldwide Medihoney licensing rights for $2,250,000,
pay off the outstanding U.S. term loan of $3,300,000 and pay off our $500,000
promissory note due April 14, 2010, leaving $494,658 of the net proceeds
available for general working capital purposes. Payment of the foregoing
indebtedness will have a positive impact on cash flow going forward by
eliminating associated debt service. The $494,658 available for working capital
was applied to reduce our outstanding line of credit balance, thereby serving to
increase the availability of funds under the line.
On March
26, 2010, our U.S. lender modified the terms of our five year revolving credit
and security agreement to take into account the payment of the term
loan. The existing financial covenants were replaced with twelve
month rolling fixed charge coverage and total debt coverage covenants. The
lender also reduced the minimum 3 month LIBOR rate from 3.00% to 1.50% and
authorized the payment of our $500,000 unsecured promissory note, which was paid
on March 31, 2010. In addition, upon condition of a satisfactory field exam by
the lender, the minimum excess availability reserve was to be reduced from
$1,500,000 to $1,000,000, thereby increasing our borrowing availability by
$500,000. In May 2010, we were advised by our lender that the minimum excess
availability reserve had been reduced to $1,000,000 upon satisfactory completion
of the field exam.
Improving
financial performance, together with the equity raise and modification to our
loan covenants in the first quarter 2010, have served to further improve our
overall liquidity.
Prospective
Assessment
Our
strategic objective is to in-license, develop and launch novel higher margined
advanced wound care products while utilizing our core business (to the extent
possible) to fund this objective. In addition, we will continue to evaluate
external opportunities to leverage our core capabilities for growth. To the
extent we determine that we cannot finance our growth initiatives internally, we
will evaluate the feasibility of doing so via the sale of equity.
The
launch of a number of new products in recent years bodes well for the future
growth of our higher-margined advanced wound care products both domestically and
abroad. We continue to work on our pipeline and have identified several product
line extensions for existing products and new products that are capable of
contributing to future sales growth. We believe that the first aid products line
continues to represent a solid growth opportunity. Sales for the balance of our
product lines are expected to remain relatively stable.
18
Our
strategy for growth is:
|
1.
|
Assuming the existing resources
in place are generating the expected return, we will continue to expand
our investment in sales and marketing resources in support of our advanced
wound care products in the U.S. Starting with ten sales representatives at
the beginning of the year, we presently have seventeen direct sales
representatives in place towards our plan of twenty by the end of
June.
|
|
2.
|
The first aid products business
represents a growth opportunity. In addition to its core business
opportunities, the first aid products business will serve as a platform
for introducing our existing advanced and traditional wound care products
to new customers and markets, especially the retail market. We continue to
work on completion of a cost effective supply chain for first aid
products. The supply chain is expected to be fully operational within the
next nine months, at which time we expect to be able to further reduce our
product costs and improve liquidity by reducing the level of inventory
required to support the
business.
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|
|
3.
|
In February 2010, we licensed the
worldwide rights to Medihoney. This will serve as the catalyst for the
expansion of our international business. Plans are in place to establish a
direct presence in Europe immediately and, ultimately, in other areas of
the world employing a direct presence or distributor model as the basis
for conducting business, as circumstances
dictate.
|
|
4.
|
We made a significant investment
in DSC 127 beginning in December 2007. While the launch of DSC 127 is
several years away, we believe the market potential for this product is
considerable. The product began Phase II trials in early 2008 to achieve
proof of principle in a human model. The Phase II trials are expected to
be completed by the end of 2010. The projected cost to complete the Phase
II trials is approximately $1,650,000, including $1,168,991 incurred
through March 2010. We plan to continue with this investment and
anticipate spending approximately $484,518 to complete the Phase II trial
over the next nine months.
|
The
results of the Phase II trial will determine the efficacy and safety of the
product and further refine its market potential. The cost of the Phase III trial
and bringing the product to market are expected to be significant. Should we
decide to proceed with the DSC 127 development plan after completion of Phase
II, we plan to fund the additional development costs out of available cash flow
or the sale of equity. Alternatively, we may determine to sublicense or sell the
rights to the compound.
With the
planned improvement in operations and expected working capital requirements,
together with the available cash on hand and available borrowing capacity as of
March 31, 2010, we anticipate having sufficient liquidity in place to meet our
operating needs and debt covenants for the foreseeable future.
Our
common stock is traded on the NASDAQ Capital Market under the symbol “DSCI.” We
have paid no cash dividends in respect of our common stock and do not intend to
pay cash dividends in the near future.
Additional Financial
Information
Forward
Looking Statements
Statements
that are not historical facts, including statements about our confidence,
strategies, expectations about new or existing products, technologies,
opportunities, market demand or acceptance of new or existing products are
forward-looking statements that involve risks and
uncertainties. These uncertainties include, but are not limited to,
product demand and market acceptance risk, impact of competitive products and
prices, product development, commercialization or technological delays or
difficulties, and trade, legal, social, financial and economic
risks.
19
Critical
Accounting Policies
Estimates
and assumptions are required in the determination of sales deductions for trade
rebates, sales incentives, discounts and allowances. Significant estimates
and assumptions are also required in determining the appropriateness of
amortization periods for identifiable intangible assets, the potential
impairment of goodwill and the valuation of inventory. Some of these
judgments can be subjective and complex and, consequently, actual results may
differ from these estimates. For any individual estimate or
assumption made by us, there may also be other reasonable estimates or
assumptions. We believe, however, that given current facts and
circumstances, it is unlikely that applying any such other reasonable judgment
would cause a material adverse effect on the consolidated results of operations,
financial position or cash flows for the periods presented. Our most
critical accounting policies are described below.
Revenue
Recognition and Adjustments to Revenue
We sell
our products through our own direct sales force and through independent
distributors and manufacturers’ representatives. The primary end
users of our products are nursing homes, hospitals, clinics and home healthcare
agencies. We recognize revenue from the sale of our products when
persuasive evidence of an arrangement exists, delivery has occurred, the sales
price is fixed and determinable, and collectability is reasonably assured, which
is generally at the time of shipment or receipt by our customers, depending on
the terms of the related sales or distribution agreement. When we
recognize revenue from the sale of our products, we simultaneously adjust
revenue for estimated trade rebates and distribution fees (in Canada), and
estimates of returns and allowances, cash discounts and other sales
incentives.
A trade
rebate represents the difference between the invoice price to the
wholesaler/distributor and the end user’s contract price. These
rebates are estimated monthly based on historical experience, distributor rebate
submission trends, estimated distributor inventory levels, and existing contract
sales terms with our distributors and end users. We have a contract
with our exclusive Canadian distributor and we pay a fixed fee based on sales
subject to the fee (as defined) for distribution services in
Canada. Because the services performed by the distributor cannot be
separated from the purchase of our products by the distributor, we treat this
distribution fee as a reduction of revenue. The distribution fee is
accrued monthly based on net sales to the distributor multiplied by the ratio of
recent historical distributor fee expense to net sales. The
percentage of distributor fee expense to net sales is re-evaluated quarterly for
reasonableness.
Sales
incentives represent credits granted to specific customers based on attainment
of pre-determined sales objectives. Sales incentives are accrued
monthly in accordance with the terms of the underlying sales incentive agreement
and actual customer sales. Sales incentive agreements are generally
for a period of one year.
We
provide our customers certain limited return rights and we have a formal
returned goods policy that guides the disposition of returns with our
customers. We accrue for sales returns and allowances and cash
discounts monthly based on current sales and historical activity. We
do not offer our customers price protection rights or concessions. Returns were
approximately 1% of gross sales in both 2009 and 2008.
We
continually monitor the factors that influence rebates and fees, returns and
allowances, and other discounts and sales incentives and make adjustments as
necessary.
Goodwill
At March
31, 2010, we had $7,119,726 of goodwill consisting of $4,679,684 relating to the
First Aid Products acquisition in November 2007 and $2,440,042 relating to the
Western Medical acquisition in April 2006. We assess the impairment
of goodwill annually in the fourth quarter or whenever events or changes in
circumstances indicate that the carrying value of goodwill may not be
recoverable. The assessment is performed using the two-step process
required by FASB accounting guidance relating to goodwill. The first
step is a review for potential impairment, while the second step measures the
amount of the impairment, if any. The first step of the goodwill
impairment test compares the fair value of a reporting unit with its carrying
amount, including goodwill. For 2009 and 2008, the first step of our
goodwill impairment test reflected a fair value in excess of the carrying value
of our reporting units. Accordingly, we did not perform the second step of this
test during these periods.
The cash
generating unit level or reporting unit at which we test goodwill for impairment
is the operating segment level as that term is used in FASB accounting guidance
relating to segment reporting. We have three operating
segments: wound care, wound closure – specialty securement devices
and skin care. Products are allocated to each segment based on the
nature and intended use of the product. All of our goodwill has been
allocated to the wound care segment as the business acquisitions which gave rise
to the goodwill were wound care businesses.
20
For 2009
and 2008 and consistent with prior periods, we estimated the fair value of our
wound care segment, using the “income approach,” where we use a discounted cash
flow model (“DCF”) in preparing our goodwill impairment
assessment. This approach calculates fair value by estimating the
after-tax cash flows attributable to a reporting unit and then discounting these
after-tax cash flows to a present value using a risk-adjusted discount
rate. We selected this method as being the most meaningful in
preparing our goodwill assessments because we believe the income approach most
appropriately measures our income producing assets.
Significant
estimates used in the fair value calculation include: (i) estimates of future
revenue and expense growth, (ii) future estimated effective tax rates, (iii)
future estimated capital expenditures, (iv) future required investments in
working capital, (v) average cost of capital, and (vi) the terminal value of the
reporting unit.
The
amount and timing of future cash flows within our DCF analysis is based on our
five year forecast. Beyond our five year forecast we assumed a
terminal value to calculate the value of cash flows beyond the last projected
period in our DCF analysis. Annual revenue growth rates in our DCF
model reflect expected growth in our advanced wound care products as well as
growth in the products which we gained access to when we acquired First Aid
Products in November of 2007 as we introduce these products across our existing
customer base. The weighted average cost of capital used to discount
cash flows for the annual 2009 goodwill impairment test was estimated to be
17%.
Over
time, our wound care segment has become an increasingly significant portion of
our overall business. For the year ended December 31, 2009, our wound
care segment accounted for approximately 95% of our consolidated
revenue. Given the significance of this segment to our overall
results, we also look to our publicly traded market value, which we may adjust
in consideration of an appropriate control premium, as an indicator of the fair
value of our wound care segment and the reasonableness of our DCF
model.
There
have been no substantial changes to the methodology employed, significant
assumptions or calculations applied in the first step of the goodwill impairment
test over the past several years.
Inventory
We write
down the value of inventory by the estimate of the difference between the cost
of the inventory and its net realizable value. The estimate takes
into account projected sales of the inventory on hand and the age of the
inventory in stock. If actual future demand or market conditions are
less favorable than those projected by management, additional inventory
write-downs may be required. The provision for the write-down of
inventory is recorded in cost of sales.
Stock-Based
Compensation
We record compensation expense
associated with stock options and other equity-based compensation based on their
fair value at the grant date and recognized over the requisite service
periods. We estimate the fair value of stock options as of the date
of grant using the Black-Scholes for service and performance based awards or
binomial/lattice pricing model for market based awards and restricted stock
based on the quoted market price. Significant judgment and the use of
estimates to value the equity-based compensation, particularly surrounding
Black-Scholes or binomial/lattice pricing model assumptions such as stock price
volatility and expected option lives, as well as expected option forfeiture
rates, are made by the Company.
21
The Company’s management, with the
participation of the Company’s Chief Executive Officer and Chief Financial
Officer, has evaluated the effectiveness of the Company’s disclosure controls
and procedures as of March 31, 2010. Based on this evaluation, the
Company’s Chief Executive Officer and Chief Financial Officer concluded that the
Company’s disclosure controls and procedures are effective for gathering,
analyzing and disclosing the information the Company is required to disclose in
the reports it files under the Securities Exchange Act of 1934, within the time
periods specified in the SEC’s rules and forms.
During the three months ended March 31,
2010, there was no change in the Company’s internal controls over financial
reporting that materially affected, or is reasonably likely to materially
affect, the Company’s internal controls over financial
reporting.
22
PART
II – OTHER INFORMATION
Item
1A. Risk Factors
The following risk factors update the
related risk factors set forth in the Company’s annual report on Form 10-K filed
with the Securities and Exchange Commission:
We
have a history of losses and can offer no assurance of future
profitability.
We
incurred losses of $534,904 for the three months ended March 31, 2010
(unaudited) $1,143,272 in 2009, $3,961,937 in 2008, $2,284,605 in 2007,
$1,099,990 in 2005, $2,338,693 in 2004, $2,581,337 in 2000 and $2,998,919 in
1999. At March 31, 2010, we had an accumulated deficit of $21,341,999
(unaudited). We cannot offer any assurance that we will be able to generate
sustained or significant future earnings.
The
potential increase in common shares due to the conversion, exercise or vesting
of outstanding dilutive securities may have a depressive effect upon the market
value of our shares.
Up to
3,187,945 shares of our common stock are potentially issuable upon the
conversion, exercise or vesting of outstanding convertible preferred stock,
warrants and options (“dilutive securities”). The shares of common stock
potentially issuable upon conversion, exercise or vesting of dilutive securities
are substantial compared to the 6,557,855 shares of common stock currently
outstanding.
Earnings
per share of common stock may be substantially diluted by the existence of these
dilutive securities regardless of whether they are converted, exercised or
issued. This dilution of earnings per share could have a depressive effect upon
the market value of our common stock.
Our
stock price has been volatile and this volatility is likely to
continue.
Historically,
the market price of our common stock has been volatile. The high and low stock
prices (after reflecting the impact of the 1-for-8 reverse split) for the years
2005 through 2009 and the first three months of 2010 are set forth in the table
below:
Derma
Sciences, Inc.
Trading
Range – Common Stock
Year
|
Low
|
High
|
||||||
2005
|
$ | 3.36 | $ | 6.24 | ||||
2006
|
$ | 3.60 | $ | 7.20 | ||||
2007
|
$ | 4.64 | $ | 11.20 | ||||
2008
|
$ | 1.60 | $ | 10.80 | ||||
2009
|
$ | 1.92 | $ | 6.80 | ||||
2010*
|
$ | 4.83 | $ | 6.40 |
(*)
January 1 through March 31.
Events
that may affect our common stock price include:
•
|
Quarter to quarter variations in
our operating results;
|
•
|
Changes in earnings estimates by
securities analysts;
|
•
|
Changes in interest rates or
other general economic
conditions;
|
•
|
Changes in market conditions in
the wound care industry;
|
•
|
Fluctuations in stock market
prices and trading volumes of similar
companies;
|
•
|
Discussion
of us or our stock price by the financial and scientific press and in
online investor communities;
|
•
|
Additions or departures of key
personnel;
|
•
|
Changes in third party
reimbursement policies;
|
23
•
|
The introduction of new products
either by us or by our competitors;
and
|
•
|
The loss of a major
customer.
|
Although
all publicly traded securities are subject to price and volume fluctuations, it
is likely that our common stock will experience these fluctuations to a greater
degree than the securities of more established and better capitalized
organizations.
Item
6. Exhibits
All
exhibits required by Item 601 of Regulation S-K and required hereunder, as filed
with the Securities and Exchange Commission in Form 10-K on March 31, 2010, are
incorporated herein by reference.
Exhibit
|
Description
|
|
31.1
|
Certification
of the Principal Executive Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
|
|
31.2
|
Certification
of the Principal Financial Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
|
|
32.1
|
Certification
of the Principal Executive Officer pursuant to U.S.C. Section 1350 as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002
|
|
32.2
|
|
Certification
of the Principal Financial Officer pursuant to U.S.C. Section 1350 as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002
|
Pursuant to the requirements of the
Securities Exchange Act of 1934, the registrant has caused this report to be
signed on its behalf by the undersigned thereunto duly authorized.
DERMA
SCIENCES, INC.
|
||
Dated: May
12, 2010
|
By:
|
/s/ John E.
Yetter
|
John
E. Yetter, CPA
|
||
Chief
Financial Officer
|
24