UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

☒	Quarterly Report pursuant to section 13 or 15(d) of the Securities Exchange Act of 1934

For the Quarterly Period Ended September 30, 2017

☐	Transition Report pursuant to section 13 or 15(d) of the Securities Exchange Act of 1934

For the Transition Period from ______ to _______.

Commission File No. 000-20970

COGENTIX MEDICAL, INC.

(Exact name of registrant as specified in its Charter)

 

 

5420 Feltl Road

Minnetonka, Minnesota, 55343

(Address of principal executive offices)

(952) 426-6140

(Registrant’s telephone number, including area code)

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 ☒  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 (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  YES ☒   NO ☐

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer”, “accelerated filer”, “smaller reporting company”, and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):

 

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extend transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act)

YES ☐  NO ☒

 

As of November 6, 2017 the registrant had 60,905,666 shares of common stock outstanding.

 

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Table of Contents

INDEX

COGENTIX MEDICAL, INC. AND SUBSIDIARIES

 

As used in this report, the terms “Cogentix”, “Cogentix Medical”, the “Company”, “we”, “us”, “our” and similar references refer to Cogentix Medical, Inc. and our consolidated subsidiaries, and the term “common stock” refers to our common stock, par value $0.01 per share.

This report contains the following trademarks, trade names and service marks of ours: PrimeSight^TM, Vision-Sciences®, EndoSheath®, Slide-On®, EndoWipe®, The Vision System®,Urgent®PC, Macroplastique®, VOX®, PTQ® and Uroplasty®.  This report also contains trademarks, trade names and service marks that are owned by other persons or entities.

FORWARD-LOOKING STATEMENTS

This quarterly report on Form 10-Q contains “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended.  Statements contained in this report that refer to our estimated or anticipated future results, including estimated synergies, or other non-historical facts are forward-looking statements that reflect our current perspective of existing trends and information as of the date of this report.  Forward-looking statements generally will be accompanied by words such as “anticipate,” “believe,” “plan,” “could,” “should,” “estimate,” “expect,” “forecast,” “outlook,” “guidance,” “intend,” “may,” “might,” “will,” “possible,” “potential,” “predict,” “project,” or other similar words, phrases or expressions.  These forward-looking statements are based on current expectations about future events affecting us and are subject to uncertainties and factors relating to our operations and business environment, all of which are difficult to predict and many of which are beyond our control and could cause our actual results to differ materially from those matters expressed or implied by our forward-looking statements.  Forward-looking statements (including oral representations) are only predictions or statements of current plans and can be affected by inaccurate assumptions we might make or by known or unknown risks and uncertainties.

When relying on forward-looking statements to make decisions with respect to the Company, our investors and others should carefully consider the foregoing factors and other uncertainties and potential events and read our filings with the SEC, including our annual report on Form 10K for the year ended December 31, 2016, for a discussion on these and other risks and uncertainties.  These filings are available at www.sec.gov.  We do not undertake any obligation to update or revise any forward-looking statement, except as may be required by law.  We qualify all forward-looking statements by these cautionary statements.

·

we may obtain additional financing, which may not be available on favorable terms at the time it is needed and which could reduce our operational and strategic flexibility;

·

we may attempt to acquire new products or technologies, and if we are unable to successfully complete these acquisitions or to integrate acquired businesses, products, technologies or employees, we may fail to realize expected benefit or harm our existing business;

·

the use and acceptance of our products depends heavily upon the availability of third-party reimbursement for the procedures in which its products are used;

·

we cannot predict how quickly or how broadly the market will accept our products;

·

that we are subject to changing federal and state regulations that could increase the cost of doing business or impose requirements with which we cannot comply;

·

changes in regulatory policy, particularly at the FDA, might adversely affect our operations;

·

if we are not able to attract, retain and motivate our sales force and expand our distribution channels, our sales and revenues will suffer;

·

the size and resources of our competitors may render it difficult for us to successfully compete in the marketplace;

·

we are primarily dependent on sales from a limited number of product lines and our business would suffer if sales of any of these product lines decline;

·

we could be subject to fines and penalties, or required to temporarily or permanently cease offering products, if we fail to comply with the extensive regulations applicable to the sale and manufacture of medical products;

·

our distributors may not obtain regulatory approvals in a timely basis, or at all;

·

we may not have the resources to successfully market our products, which would adversely affect our business and results of operations;

·

if we cannot attract and retain our key personnel and management team, we may not be able to manage and operate successfully, and we may not be able to meet our strategic objectives;

·

if third parties claim that we infringe upon their intellectual property rights, we may incur liabilities and costs and may have to redesign or discontinue selling the affected product;

 

·

if we are unable to adequately protect our intellectual property rights, we may not be able to compete effectively;

·

product liability claims could adversely affect our business and results of operations;

·

security breaches and other disruptions could compromise our information and expose us to liability, which would cause our business and reputation to suffer;

·

the loss or interruption of materials from any of our key suppliers could delay the manufacture of our products, which would limit our ability to generate sales and revenues;

·

if we are not able to maintain sufficient quality controls, regulatory approvals of our products by the European Union, Canada, the FDA or other relevant authorities could be delayed or denied and our sales and revenues will suffer;

·

if we are not able to acquire or license other products, our business and future growth prospects could suffer;

·

our business strategy relies on assumptions about the market for our products, which, if incorrect, would adversely affect our business prospects and profitability;

·

we derive a significant portion of our sales and revenues from outside of the U.S. and we are subject to the risks of international operations;

·

failure to comply with the U.S. Foreign Corrupt Practices Act could subject us to, among other things, penalties and legal expenses that could harm our reputation and have a material adverse effect on our business, financial condition and operating results;

·

our stock is thinly traded and you may find it difficult to sell your investment in our stock at quoted prices;

·

our stock price may fluctuate and be volatile;

·

future sales of our common stock in the public market could lower our share price;

·

we are exempt from certain corporate governance requirements due to our status as a "controlled company" within the meaning of the Nasdaq rules, including certain rules related to board independence;

·

our corporate documents contain provisions that could discourage, delay or prevent a change in control of the company; and

·

we do not intend to declare dividends on our stock in the foreseeable future.

 

PART I. FINANCIAL INFORMATION

 

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ITEM 1.

FINANCIAL STATEMENTS

COGENTIX MEDICAL, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)

See accompanying notes to the Condensed Consolidated Financial Statements.

 

COGENTIX MEDICAL, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)

 

See accompanying notes to the Condensed Consolidated Financial Statements.

 

COGENTIX MEDICAL, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

 

See accompanying notes to the Condensed Consolidated Financial Statements.

 

COGENTIX MEDICAL, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(Unaudited)

 

See accompanying notes to the Condensed Consolidated Financial Statements.

 

COGENTIX MEDICAL, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY

Nine Months Ended September 30, 2017

(Unaudited)

 

 

See accompanying notes to the Condensed Consolidated Financial Statements.

 

COGENTIX MEDICAL, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

 (Unaudited)

 

See accompanying notes to the Condensed Consolidated Financial Statements.

 

COGENTIX MEDICAL, INC. AND SUBSIDIARIES

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 1. Summary of Significant Accounting Policies

Basis of Presentation

Cogentix Medical, Inc. (the “Company”) is a global medical device company headquartered in Minnetonka, Minnesota, with additional operations in New York, Massachusetts, The Netherlands and the United Kingdom.  We design, develop, manufacture and market a robust line of high performance fiberoptic and video endoscopy products under the PrimeSight^TM brand that are used across multiple surgical specialties in diagnostic and treatment procedures, with our focus being on the urology market.  We also offer the Urgent^® PC Neuromodulation System, a device that delivers percutaneous tibial nerve stimulation (“PTNS”), for the office-based treatment of overactive bladder (“OAB”).  OAB is a chronic condition that affects approximately 40 million adults in the U.S.  The symptoms include urinary urgency, frequency and urge incontinence.  We also offer Macroplastique^® Implants, an injectable urethral bulking agent for the treatment of adult female stress urinary incontinence that is primarily due to intrinsic sphincter deficiency.  Outside the U.S., we market additional bulking agents: PTQ^® for the treatment if fecal incontinence and VOX^® for vocal cord augmentation.

 

We have prepared our Condensed Consolidated Financial Statements included in this quarterly report on Form 10-Q, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”).  Certain information and footnote disclosures normally included in the consolidated financial statements prepared in accordance with accounting principles generally accepted in the United States of America, or GAAP, have been condensed or omitted, pursuant to such rules and regulations, although we believe that our disclosures are adequate to make the information not misleading.  The consolidated results of operations for any interim period are not necessarily indicative of results for a full fiscal year.  These Condensed Consolidated Financial Statements, presented herein, should be read in conjunction with the audited consolidated financial statements and related notes included in our annual report on Form 10-K for the year ended December 31, 2016.

The Condensed Consolidated Financial Statements presented herein as of September 30, 2017 and for the three and nine month periods ended September 30, 2017 and 2016, reflect, in the opinion of management, all material adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the consolidated financial condition, results of operations and cash flows for the interim periods.

We have identified certain accounting policies that we consider particularly important for the portrayal of our results of operations and financial condition and which may require the application of a higher level of judgment by our management, and as a result are subject to an inherent level of uncertainty.  These are characterized as “critical accounting policies” and address revenue recognition, accounts receivable, valuation of inventory, foreign currency translation/transactions, the determination of recoverability of long-lived and intangible assets, share-based compensation, defined benefit pension plans and income taxes, each of which is described in our annual report on Form 10-K for the year ended December 31, 2016.  Based upon our review, we have determined that these policies remain our most critical accounting policies for the nine months ended September 30, 2017. We have adopted two additional policies during 2017.  The first policy is for the adoption of Accounting Standards Update (“ASU”) 2016-09, “Improvements to Employee Share-Based Payment Accounting.”  Under the new ASU we no longer account for forfeitures of restricted stock awards and stock options throughout the vesting period and instead account for them in the period in which they occur.  We also recognize certain tax benefits or tax shortfalls upon a restricted-stock award vesting or stock option exercise relative to the deferred tax asset position established in the provision for income taxes line of the consolidated statements of operations instead of within the consolidated statement of shareholders’ equity.  The second policy is for the adoption of Accounting Standards Codification (“ASC”) 323, “Investments – Equity Method and Joint Ventures.” This ASC establishes accounting guidelines for an equity investment in which the Company has the ability to exercise significant influence, but does not have a controlling interest.  In this situation, the equity method should be applied to an investment.  Significant influence is generally considered to exist when the Company has an ownership interest in the voting stock of an entity between 20% and 50%, and other factors, such as representation on the Board of Directors, are considered in determining whether the equity method of accounting is appropriate.  We adopted this policy for our equity investment in Vensica Medical, as described in Note 12 to the financial statements.

Note 2. New Accounting Pronouncements

Recently Adopted Accounting Pronouncements

In March 2016, the Financial Accounting Standards Board (“FASB”) issued ASU 2016-09, “Improvements to Employee Share-Based Payment Accounting.” This ASU simplifies several aspects of the accounting for employee share-based payment transactions, including the accounting for income taxes, forfeitures, and statutory tax withholding requirements, as well as classification in the statement of cash flows. This new standard is effective for annual periods beginning after December 15, 2016, and interim periods within that reporting period.  We adopted this standard as of January 1, 2017. The adoption did not have a material impact on our consolidated financial statements.  Under the new ASU we no longer account for forfeitures of restricted stock awards and stock options throughout the vesting period and instead account for them in the period in which they occur.  We also recognize certain tax benefits or tax shortfalls upon a restricted-stock award vesting or stock option exercise relative to the deferred tax asset position established in the provision for income taxes line of the consolidated statements of operations instead of within the consolidated statement of shareholders’ equity.

 

In August 2016, the FASB issued ASU No. 2016-15, “Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments.”  This ASU is in response to diversity in practice in how certain cash receipts and cash payments are presented and classified in the statement of cash flows and provides guidance on eight specific cash flow classification issues.  It will be effective for reporting periods beginning after December 15, 2017, and interim periods within that reporting period.  Early adoption is permitted, including adoption in an interim period.  The Company adopted this standard as of January 1, 2017.  The adoption did not have a material impact on our consolidated financial statements.

Recently Issued Accounting Pronouncements Not Yet Adopted

 

 

In March 2017, the FASB issued ASU 2017-08, “Receivables - Nonrefundable Fees and Other Costs: Premium Amortization on Purchased Callable Debt Securities” related to the amortization period for certain purchased callable debt securities held at a premium. The amendments shorten the amortization period for the premium to the earliest call date. The amendment is effective for interim and annual periods beginning after December 15, 2018. The Company does not expect these amendments to have a material effect on its consolidated financial statements.

 

In January 2017, the FASB, issued ASU No. 2017-04, “Intangibles - Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment” which simplifies the accounting for goodwill impairment by eliminating Step 2 of the current goodwill impairment test.  Goodwill impairment will now be the amount by which the reporting unit’s carrying value exceeds its fair value, limited to the carrying value of the goodwill. The standard is effective for us beginning January 1, 2020. Early adoption is permitted for any impairment tests performed after January 1, 2017. The new guidance is not expected to have a material impact on our results of operations and financial position.

In February 2016, the FASB issued ASU 2016-2, “Leases”, under which lessees will recognize most leases on-balance sheet. This will generally increase reported assets and liabilities. For public entities, this ASU is effective for annual and interim periods in fiscal years beginning after December 15, 2018. ASU 2016-2 mandates a modified retrospective transition method for all entities. While the Company is still evaluating the timing and impact of the adoption of this guidance on its consolidated financial statements, it anticipates that the adoption could result in an increase in the assets and liabilities recorded on its consolidated balance sheet.

In May 2014, the FASB issued ASU 2014-09, “Revenue from Contracts with Customers (Topic 606)”, as amended by ASU 2015-14, “Deferral of Effective Date”, which requires an entity to recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. ASU 2014-09 sets forth a new revenue recognition model that requires identifying the contract, identifying the performance obligations, determining the transaction price, allocating the transaction price to performance obligations and recognizing the revenue upon satisfaction of performance obligations. For public entities, this ASU is effective for annual reporting periods beginning after December 15, 2017 including interim reporting periods within that reporting period. The provisions can be adopted either retrospectively to each prior reporting period presented or as a cumulative-effect adjustment as of the date of adoption. We plan to adopt this ASU effective January 1, 2018 using the cumulative-effect adjustment method.  The Company has completed the assessment of this ASU on each of our revenue streams and, based on our review of contracts, we believe the impact on our consolidated financial statements will be immaterial.  For each of our products, revenue will still be recognized when title passes to the customer, generally upon shipment.  Revenue for service repairs of equipment will continue to be recognized after service has been completed, and service contract revenue will be recognized ratably over the term of the contract.  We are still evaluating the impact of the new revenue recognition standard on our disclosures due to the new qualitative and quantitative requirements under the standard.

 

Note 3.  Business Combination

The Company, through its wholly owned subsidiary, Uroplasty LTD, acquired 100% of the issued share capital in Genesis Medical Holdings LTD (“Genesis”) and its subsidiaries effective July 25, 2017 (the “Genesis Acquisition”).

The Genesis Acquisition has been accounted for in accordance with Accounting Standards Codification (ASC) Topic 805, "Business Combinations".   The terms of the Genesis Acquisition include an upfront payment equal to the estimated fair market value of the tangible net assets, approximately $280,000.  The terms also include a purchase price for the ongoing business of approximately $556,000, payable at the rate of 5% of Genesis revenue on a monthly basis.  In addition, if Genesis achieves revenue of approximately $4.7 million for the twelve months ended March 31, 2019, the Company will pay an additional amount of approximately $134,000. We have determined the likelihood of paying the $134,000 as probable.  The note payable and the contingent consideration have been discounted to a net present value equal to approximately $618,000.  All conversions between British Pounds and U.S. Dollars were computed using the July 25, 2017 exchange rate of $1.34 per £1.

 

Under the acquisition method of accounting, the total purchase price was allocated to the net tangible and intangible assets of Genesis based on their fair values at the effective date of the Acquisition. The preliminary allocation is approximately as follows:

Cash paid to Genesis, net of cash acquired of $84,000, totaled approximately $197,000.  The remaining purchase price was financed via a note payableand contingent consideration as described above.

Legal costs directly related to the acquisition of approximately $40,000 and approximately $50,000 have been charged directly to operations and are included in general and administrative expense in our Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2017.

The goodwill of $398,190 resulting from the acquisition is the excess if the purchase price over the fair value of the net assets acquired.  The goodwill primarily reflects the value of enhancing our market opportunity and growth potential in the U.K.   None of the goodwill recognized is deductible for income tax purposes as it was a stock acquisition and as such, no deferred taxes have been recorded to goodwill.

The allocation of the purchase price to the net assets acquired and liabilities assumed resulted in the recognition of the following identifiable intangible asset:

 

Note 4. Goodwill and Other Intangible Assets

Goodwill

There was no change in the goodwill balance as of September 30, 2017 as compared to December 31, 2016 other than the addition of approximately $400,000 related to the Genesis Acquisition as described in Note 3.

Other Intangible Assets

Other intangible assets consisted of approximately the following at September 30, 2017 and December 31, 2016:

For the nine months ended September 30, 2017 and 2016, amortization of intangible assets charged to operations was approximately $1,781,000 and $1,773,000, respectively.

Estimated amortization expense for all intangible assets as of September 30, 2017 is approximately as follows:

Note 5. Fair Value Measurements

Estimates of fair value for financial assets and liabilities are based on the framework established in the accounting guidance for fair value measurements.  The framework defines fair value, provides guidance for measuring fair value and requires certain disclosures.  The framework prioritizes a fair value hierarchy that requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.  The following three broad levels of inputs may be used to measure fair value under the fair value hierarchy:

·

Level 1: Observable inputs such as quoted prices (unadjusted) in active markets for identical assets or liabilities.

·

Level 2: Inputs other than quoted prices that are observable for the asset or liability, either directly or indirectly.  These include quoted prices for similar assets or liabilities in active markets and quoted prices for identical or similar assets or liabilities in markets that are not active.

·

Level 3: Significant unobservable inputs that cannot be corroborated by observable market data and reflect the use of significant management judgment.  These values are generally determined using pricing models for which the assumptions utilize management's estimates of market participant assumptions.

If the inputs used to measure the financial assets and liabilities fall within more than one of the different levels described above, the categorization is based on the lowest level input that is significant to the fair value measurement of the instrument.

 

The following table shows our cash and available-for-sale securities’ adjusted cost, gross unrealized gains, gross unrealized losses and fair value by significant investment category recorded as cash and cash equivalents or short- or long-term investments as of September 30, 2017:

We consider all cash on-hand and highly liquid investments with original maturities of three months or less when purchased to be cash equivalents.  We classify marketable securities having original maturities of more than three months when purchased and remaining maturities of one year or less as short-term investments and marketable securities with remaining maturities of more than one year as long-term investments.  We further classify marketable securities as available-for-sale.  We have not designated any of our marketable securities as trading securities or as held to maturity. We may sell any of our marketable securities prior to their stated maturities for strategic reason including, but not limited to, anticipation of credit deterioration and duration management. The long-term securities have a contractual term that ranges from November 2018 to December 2018.

We consider the declines in market value of our marketable securities investment portfolio to be temporary in nature.  We typically invest in highly-rated securities, and our investment policy generally limits the amount of credit exposure to any one issuer.

Cash and cash equivalents of approximately $15.4 million and $9.4 million at September 30, 2017 and December 31, 2016, respectively, include highly liquid money market funds and debt securities with original maturities of three months or less totaling approximately $11.4 million and $5.6 million at September 30, 2017 and December 31, 2016 respectively.  Money market funds present negligible risk of changes in value due to changes in interest rates, and their cost approximates their fair market value.  We maintain cash in bank accounts, which, at times, may exceed federally insured limits.  We have not experienced any losses in such accounts.  Cash and cash equivalents held in foreign bank accounts totaled approximately $864,000 and approximately $507,000 at September 30, 2017 and December 31, 2016, respectively.

In connection with the Genesis Acquisition discussed in Note 3, we are required to make a payment of approximately $134,000 if certain revenue targets are achieved by Genesis for the twelve months ended March 31, 2019.   The fair value of the contingent liability recognized upon acquisition, and classified as other non-current liability, was approximately $123,000, and was estimated by discounting to present value the probability-weighted contingent payments expected to be made. Assumptions used in this calculation included the discount rate and various probability factors. This liability is considered to be a Level 3 financial liability that is re-measured each reporting period.

We have estimated the fair value of the contingent consideration based on the probability of achieving the specified revenue thresholds at 100%. A significant increase (decrease) in our estimates of achieving the relevant targets could materially increase (decrease) the fair value of the contingent consideration liability.

Note 6. Line of Credit

We have a loan agreement with Venture Bank, a Minnesota banking corporation, providing us with a $7.0 million secured revolving credit facility (the “Facility”), subject to eligible accounts receivable and inventory, and secured by substantially all our assets.  The Facility was amended in March 2017.  Under the amended Facility, the Facility will expire on September 18, 2018.

 

Under the Facility, we may borrow the lesser of: (a) the sum of (i) eighty percent (80%) of the value of eligible accounts receivable; and (ii) forty percent (40%) of the value of eligible inventory capped at $2.5 million; or (b) $7 million.  As of September 30, 2017, based on eligible receivables and inventory, our total available borrowing base was approximately $6,250,000.  We did not have any borrowings under the facility as of September 30, 2017.

Loans under the Facility bear interest at a rate per annum equal to the Wall Street Journal Prime Rate plus 1.25%, provided that in no case will the interest charged be less than 5.25%.  In the event that there is an event of default under the Facility, the interest rate will be increased by 6.0% for the entire period that an event of default exists.  In addition, the Borrowers will pay a non-usage fee of 0.15% based on the average unused and available portion of the Facility on a monthly basis.

Genesis has a Factoring Agreement with Lloyds Bank in the United Kingdom.  Pursuant to the terms of the Factoring Agreement, Genesis may offer for sale, and Lloyd’s Bank may purchase, certain accounts receivable of Genesis. The Factoring Agreement was last amended on March 6, 2017.  The maximum amount that can be factored at any given period is approximately $470,000.  As of September 30, 2017, the factoring balance was approximately $64,000.

Note 7. Inventories

Inventories are stated at the lower of cost (first-in, first-out method) or market (net realizable value).  We value at lower of cost or market the slow moving and obsolete inventories based upon current and expected future product sales and the expected impact of product transitions or modifications.  Inventories consist of approximately the following:

Note 8. Net Income (Loss) per Common Share

We calculate basic net income (loss) per common share amounts by dividing net income (loss) by the weighted-average common shares outstanding.  For calculating diluted net income (loss) per common share amounts, we add additional shares to the weighted-average common shares outstanding for the assumed exercise of stock options and vesting of restricted shares, if dilutive.  The following table sets forth the computation of our basic and diluted net income (loss) per share:

 

		Three Months Ended September 30,								Nine Months Ended September 30,
		2017				2016				2017				2016
Restricted stock			774,647				305,432				774,647				899,333
Common stock options			2,618,768				1,549,905				2,618,769				1,699,905
Common stock warrants			-				376,123				-				376,123
			3,393,415				2,231,460				3,393,415				2,975,361

Note 9. Shareholders’ Equity

Share-based compensation.  On September 30, 2017, the Company had one active plan, the Cogentix Medical 2015 Omnibus Incentive Plan, for share-based compensation grants (“the 2015 Plan”). Under the 2015 Plan, if we have a change in control (as defined in the 2015 Plan) and the Company is not the surviving entity, all outstanding grants, including those subject to vesting or other performance targets, fully vest immediately if they are not assumed or replaced with equivalent grants.  If the Company is the surviving entity, there is no accelerated vesting of equity grants solely upon a change in control.  In 2016, the Company experienced a change in control for which it was the surviving entity.  Outstanding grants will vest if a participant’s employment or other service with the Company is terminated, without cause or by the participant for good reason, within two years of the November 3, 2016 change in control.  Under the 2015 Plan, we reserved 2,500,000 shares of our common stock for share-based grants and 64,223 shares remain available for grant on September 30, 2017.

We grant options at the discretion of our directors.  We grant option awards with an exercise price equal to the closing market price of our stock at the date of the grant.  We have options outstanding to purchase 2,618,768 shares of common stock granted under the 2015 Plan or predecessor companies’ plans.  Options generally expire over a period ranging from seven to ten years from date of grant and vest at varying rates ranging up to three years.  The options granted under the 2015 Plan generally provide for the exercise of options during a limited period following termination of employment, death or disability.

We determined the fair value of our option awards using the Black-Scholes option pricing model.  We used the following weighted-average assumptions to value the options granted during the nine months ended September 30:

The expected life for options granted represents the period of time we expect options to be outstanding based on historical data of option holder exercise and termination behavior for similar grants.  The risk-free interest rate for periods within the contractual life of the option is based on the U.S. Treasury rate over the expected life at the time of grant.  Expected volatility is based upon historical volatility of our stock.

The following table summarizes the activity related to our stock options during the nine months ended September 30, 2017:

The total fair value of stock options that vested during the nine months ended September 30, 2017 and 2016 was approximately $223,000 and $268,000, respectively.

 

We grant restricted shares at the discretion of our directors with vesting terms ranging from six months to three years.  The following table summarizes the activity related to our restricted shares during the nine months ended September 30, 2017:

The aggregate intrinsic value shown above for the restricted shares represents the total pre-tax value based on the closing price of our common stock at the end of each period.

We recognize share-based compensation expense in our Condensed Consolidated Statements of Operations based on the fair value at the time of grant of the share-based payment over the requisite service period.  We incurred approximately $1,131,000 and $440,000 in share-based compensation expense for the nine months ended September 30, 2017 and 2016, respectively.

On September 30, 2017, we had approximately $883,000 of unrecognized share-based compensation expense related to stock options that we expect to recognize over a weighted-average period of approximately 2.37 years.

On September 30, 2017, we had approximately $684,000 of unrecognized share-based compensation expense related to restricted shares that we expect to recognize over a weighted-average period of approximately 1.72 years.

Note 10. Savings and Retirement Plans

We sponsor various retirement plans for eligible employees in the United States, the United Kingdom, and The Netherlands. Our retirement savings plan in the United States conforms to Section 401(k) of the Internal Revenue Code and participation is available to substantially all employees. We may also make discretionary contributions ratably to all eligible employees. We made discretionary contributions to the U.S. plan of $432,000 and $308,000 for the nine months ended September 30, 2017, and 2016, respectively.

Our international subsidiaries have defined benefit retirement plans for eligible employees.  These plans provide benefits based on the employee’s years of service and compensation during the years immediately preceding retirement, termination, disability, or death, as defined in the plans.

The cost for our defined benefit retirement plans in The Netherlands and the United Kingdom includes the following components for the three- and nine-month periods ended September 30:

 

Note 11. Business Segment Information

ASC 280, “Segment Reporting,” establishes disclosure standards for segments of a company based on management’s approach to defining operating segments.  Reportable segments are defined primarily by the nature of products and services, the nature of the production processes, and the type of customers for our products and services.

 

For financial reporting purposes, we report one operating segment as our Chief Operating Decision Maker utilizes financial statement information provided to him on a consolidated basis.

 

 Information regarding geographic area net sales to customers for the three and nine months ended September 30, is approximately as follows:

 

(1)	No other country accounts for 10% of more of the consolidated net sales.

Information regarding geographic area long-lived assets is approximately as follows:

Accounting policies of the operations in the various geographic areas are the same as those described in Note 1.  Net sales attributed to each geographic area are net of intercompany sales.  No single customer represents 10% or more of our consolidated net sales.  Long-lived assets consist of property, plant and equipment.

Note 12. Equity Investment

ASC 323, “Investments – Equity Method and Joint Ventures,” establishes accounting guidelines for an equity investment in which the Company has the ability to exercise significant influence, but does not have a controlling interest.  In this situation, the equity method should be applied to an investment.  Significant influence is generally considered to exist when the Company has an ownership interest in the voting stock of an entity between 20% and 50%, and other factors, such as representation on the Board of Directors, are considered in determining whether the equity method of accounting is appropriate.

On September 28, 2017, we made an equity investment in Vensica Medical (“Vensica”), a privately-held Israeli-based company developing VensiCare, an ultrasound based, needle-free drug delivery system.  Our $2 million investment gave us a 20% ownership in the company and allows us to have one seat on the Vensica Medical Board of Directors along with two call options to acquire the entire company for an additional $8 million.  The investment is accounted for using the equity method of accounting because the Company has significant influence, but not control, of the entity.  Due to the timing of this investment, we did not earn any income (loss) in Vensica Medical for the three and nine-month period ended September 30, 2017.

Note 13. Subsequent Event

None.

 

ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Forward-looking Statements

We recommend that you read this quarterly report on Form 10-Q in conjunction with our annual report on Form 10-K for the year ended December 31, 2016.

You should read the following discussion of our financial condition and results of operation together with the unaudited, condensed, consolidated financial statements and the notes thereto included elsewhere in this report and other financial information included in this report.  The following discussions may contain predictions, estimates and other forward-looking statements that involve a number of risks and uncertainties, as we discussed in our special note regarding “Forward-Looking Statements” beginning on page 3 of this report and under “Part I - Item 1A. Risk Factors” in our annual report on Form 10-K for the year ended December 31, 2016.  These risks could cause our actual results to differ materially from any further performance suggested below.

We do not undertake, nor assume any obligation, to update any forward-looking statement that we may make from time to time.

Overview

Cogentix Medical is a global medical device company headquartered in Minnetonka, Minnesota, with additional operations in New York, Massachusetts, The Netherlands and the United Kingdom.  We design, develop, manufacture and market a robust line of high performance fiberoptic and video endoscopy products under the PrimeSight^TM brand that are used across multiple surgical specialties in diagnostic and treatment procedures, with our focus being on the urology market.  We also offer the Urgent® PC Neuromodulation System, a device that delivers percutaneous tibial nerve stimulation (“PTNS”), for the office-based treatment of overactive bladder (“OAB”).  OAB is a chronic condition that affects approximately 40 million adults in the U.S.  The symptoms include urinary urgency, frequency and urge incontinence.  We also offer Macroplastique® Implants, an injectable urethral bulking agent for the treatment of adult female stress urinary incontinence that is primarily due to intrinsic sphincter deficiency.  Outside the U.S., we market additional bulking agents: PTQ^® for the treatment if fecal incontinence and VOX^® for vocal cord augmentation.

Critical Accounting Policies

We prepare our consolidated financial statements in accordance with U.S. generally accepted accounting principles, or GAAP, which require us to make estimates and assumptions in certain circumstances that affect amounts reported.  In preparing these consolidated financial statements, we have made our best estimates and judgments of certain amounts, giving due consideration to materiality.

Results of Operations

Three months ended September 30, 2017 compared to three months ended September 30, 2016

Net Sales:  Consolidated net sales of $13,765,000 in the current period represented a $357,000 increase, or 2.7%, over net sales of $13,408,000 in the prior period.  The increase is primarily due to a $422,000 net increase in revenue from the Urology product lines, which is comprised of the PrimeSight, Urgent PC and other urology products, and is offset by a $65,000 net decrease in revenue from the non-core Airway Management and Industrial product lines.

Consolidated net sales for PrimeSight urology products of $4,293,000 in the current period represented a $114,000 decrease, or 2.6%, over net sales of $4,407,000 in the prior period.  Our PrimeSight endoscopes are capital purchases for our customers, and such capital sales can vary from quarter to quarter.  In the third quarter of 2016, the Company had its largest sale to date of capital equipment to one customer and there was no comparable sale in the third quarter of 2017.  Year to date through September 30, 2017, PrimeSight urology revenue has increased by 26% over the same period of 2016.

 

Consolidated net sales of our Urgent PC System of $5,360,000 in the current period represented a $150,000 increase, or 2.9%, when compared to net sales of $5,210,000 in the prior period. The increase is due to increased utilization within existing accounts.

Consolidated net sales of our Macroplastique product of $1,715,000 in the current period represented a $44,000 increase, or 2.6%, over net sales of $1,671,000 in the prior period.  Macroplastique serves a small market, and the focus of our sales force has been on growing sales of our PrimeSight urology and Urgent PC products.

Consolidated net sales of other urology products of $550,000 in the current period represented a $342,000 increase, or 164.4%, over net sales of $208,000 in the prior period.  The increase is due primarily to non-PrimeSight revenue from the Genesis Acquisition described in Note 3 to the financial statements.

Consolidated net sales of our non-urology products (Airway Management and Industrial Boroscopes) of $1,847,000 in the current period represented a $65,000 decrease, or 3.4%, over net sales of $1,912,000 in the prior period.  The decrease is primarily due to our increased focus on Urology products.  Additionally, we are exploring strategic alternatives for our non-Urology Airway Management and Industrial product lines.

Consolidated net sales to customers in the U.S. of $10,415,000 in the current period represented a decrease of $425,000, or 3.9%, over net sales of $10,840,000 in the prior period. Consolidated net sales to customers outside the U.S. of $3,350,000 in the current period represented an increase of $782,000, or 30.5%, over net sales of $2,568,000 in the prior period.

Gross Profit:  Gross profit was $9,395,000, or 68.3% of net sales in the current period, compared to $9,038,000, or 67.4% of net sales in the prior period.  The increase in gross profit percentage is attributed primarily to product mix.  Revenue from our higher margin Urgent PC and Macroplastique products were a higher proportion of total sales in the current quarter than the prior quarter.

Operating Expenses: Operating expenses in the current period totaled approximately $9,589,000, compared to approximately $8,517,000 in the prior period, an increase of approximately $1,072,000.  The increase was primarily attributable to share based compensation expense, business development costs, operating costs from the Genesis Acquisition described in Note 3 to the financial statements and the expansion of the U.S. sales force.  Operating expenses included:

General and Administrative Expenses (G&A):  G&A expenses of $2,056,000 in the current period increased $498,000 from $1,558,000 in the prior period.  The increase is attributed primarily to a $192,000 increase of share based compensation expense and approximately $208,000 of business development costs as well as inclusion of approximately $100,000 for the operating costs of Genesis.

Research and Development Expenses (R&D):  R&D expenses of $1,234,000 in the current period decreased $16,000 from $1,219,000 in the prior period.

Selling and Marketing Expenses (S&M):  S&M expenses of $5,698,000 in the current period increased $494,000, from $5,203,000 in the prior period.   The increase is attributed primarily to the expansion of the U.S sales force as well as the addition of five sales personnel from the Genesis Acquisition.

One-time Costs: In the first half of 2016, the Company incurred one-time costs related to the proxy contest between the Company and Mr. Lewis Pell (a current director) and related litigation.  In the third quarter of 2016, the Company received a $54,000 refund of professional fees.  There were no similar costs or refunds in the current period.

Amortization of Intangible Assets: Amortization of intangible assets was $602,000 in the current period compared to $591,000 in the prior period.

Other Income (Expense):  Other income (expense) includes interest income, interest expense, foreign currency exchange and other non-operating costs when incurred.  Net other income was $61,000 in the current period compared to net other expense of $396,000 in the prior period.  Other income in the current quarter is primarily interest income from our investments.  Interest expense in the prior year is primarily due to interest on related party debt that was converted into equity in the fourth quarter of 2016.

Income Tax Expense:  We recorded income tax expense of approximately $26,000 in the current period and $19,000 in the prior period.  Income tax expense is attributed to our European subsidiaries and to the payment of minimum taxes in the U.S.

 

Net Income (Loss):  Net loss was approximately $160,000 ($0.00 per share) in the current period compared to net income of approximately $106,000 ($0.00 per share) in the prior period.

Nine months ended September 30, 2017 compared to nine months ended September 30, 2016

Net Sales:  Consolidated net sales of $40,779,000 in the current period represented a $2,160,000 increase, or 5.6%, over net sales of $38,619,000 in the prior period.  The increase is primarily due to a $2,850,000 net increase in revenue from the Urology product lines, which is comprised of the PrimeSight, Urgent PC and other urology products, and is offset by a $572,000 net decrease in revenue from the Airway Management and Industrial product lines.

Consolidated net sales for PrimeSight urology products of $13,735,000 in the current period represented a $2,850,000 increase, or 26.2%, over net sales of $10,885,000 in the prior period.  The increase is primarily due to our sales force becoming more proficient in selling this technology as well the fact that our PrimeSight technology platform meets the needs of our medical customers for always ready, always sterile flexible endoscopy solutions. Our urology PrimeSight products have been clinically proven to reduce the risk of cross contamination associated with the reuse or reprocessing of difficult to clean conventional endoscopes and they also reduce the typical 45-minute reprocessing time to less than 10 minutes, allowing for greater patient throughput, increased physician productivity and ultimately economic benefit for our customers.

Consolidated net sales of our Urgent PC System of $15,602,000 in the current period represented a $118,000 decrease, or 0.8%, when compared to net sales of $15,720,000 in the prior period.  U.S. unit growth was offset by a 4% decline in average selling price.  U.S. unit growth was due primarily to sales execution and increased penetration in existing accounts.  Our sales team has effectively demonstrated the clinical efficacy and value proposition of Urgent PC to our physician customers resulting in the increased sales. The sales team continues to place a strong emphasis on servicing existing accounts and increasing utilization within existing accounts.  The decrease in average selling price is primarily due to the continued sales efforts of a large competitor who entered the PTNS space in the first quarter of 2016.  Average selling prices have been substantially consistent over the past four quarters.

Consolidated net sales of our Macroplastique product of $5,237,000 in the current period represented a $273,000 decrease, or 5.0%, over net sales of $5,510,000 in the prior period.  Macroplastique serves a small market, and the focus of our sales force has been on growing sales of our PrimeSight urology and our Urgent PC products.

 Consolidated net sales of other urology products of $1,071,000 in the current period represented a $273,000 increase, or 34.2%, over net sales of $789,000 in the prior period.  The increase is due primarily to non-PrimeSight revenue from the Genesis Acquisition.

Consolidated net sales of our non-urology products of $5,134,000 in the current period represented a $572,000 decrease, or 10.0%, over net sales of $5,706,000 in the prior period.  The decrease is primarily due to our increased focus on Urology products.  Additionally, we are exploring strategic alternatives for our non-Urology Airway Management and Industrial product lines.

Consolidated net sales to customers in the U.S. of $29,990,000 in the current period represented an increase of $611,000, or 2.1%, over net sales of $29,379,000 in the prior period. Consolidated net sales to customers outside the U.S. of $10,789,000 in the current period represented an increase of $1,549,000, or 16.8%, over net sales of $9,240,000 in the prior period.

Gross Profit:  Gross profit was $27,257,000, or 66.8% of net sales in the current period, compared to $26,361,000, or 68.3% of net sales in the prior period.  The change in gross profit percentage is attributed primarily to product mix, as revenue from our PrimeSight products were a higher proportion of total sales in the currentperiod as compared to the same period of the prior year, and our PrimeSight products have a lower profit percentage than our Urgent PC and Macroplastique products.

Operating Expenses: Operating expenses in the current period totaled approximately $28,288,000 compared to approximately $28,646,000 in the prior period, a decrease of $359,000.  Operating expenses included:

General and Administrative Expenses (G&A):  G&A expenses of $6,250,000 in the current period increased $1,162,000 from $5,088,000 in the prior period.  The increase is attributed primarily to an increase of $655,000 in share based compensation expense and approximately $398,000 of business development costs.

Research and Development Expenses (R&D):  R&D expenses of $3,557,000 in the current period increased $301,000 from $3,256,000 in the prior period.  The increase is attributed to ongoing enhancements to our PrimeSight product line.

 

Selling and Marketing Expenses (S&M):  S&M expenses of $16,700,000 in the current period increased $427,000, from $16,273,000 in the prior period.  The increase is attributed primarily to the expansion of the U.S sales force and is partially offset by a $372,000 for an IRS tax refund related to medical device taxes paid in 2013 -2015.

One-time Costs: One-time costs in the prior period related to the proxy contest settlement between the Company and Mr. Lewis Pell and related litigation in connection with the 2016 Annual Meeting.  These fees included $758,000 of professional fees (primarily legal) and $1,500,000 of severance costs for the Company’s former CEO.  There were no similar costs in the current period.

Amortization of Intangible Assets: Amortization of intangible assets was $1,781,000 in the current period compared to $1,773,000 in the prior period.

Other Income (Expense):  Other income (expense) includes interest income, interest expense, foreign currency exchange and other non-operating costs when incurred.  Net other income was $221,000 in the current period compared to net other expense of $1,187,000 in the prior period.  Other income in the current period is primarily interest income from our investments.  Interest expense in the prior year is primarily due to interest on related party debt that was converted into equity in the fourth quarter of 2016.

Income Tax Expense:  We recorded income tax expense of approximately $141,000 in the current period and $52,000 in the prior period.  Income tax expense is attributed to our European subsidiaries and to the payment of minimum taxes in the U.S.

Net Income (Loss):  Net loss was approximately $951,000 ($0.02 per share) in the current period compared to a net loss of approximately $3,525,000 ($0.14 per share) in the prior period.

Non-GAAP Financial Measures:  The following tables reconcile our operating income (loss) calculated in accordance with GAAP to non-GAAP financial measures that exclude non-cash charges for share-based compensation expense, depreciation and amortization.  The non-GAAP financial measures used by management and disclosed by us are neither a substitute for, nor superior to, financial measures and consolidated financial results calculated in accordance with GAAP, and you should carefully evaluate our reconciliations to non-GAAP.  We may calculate our non-GAAP financial measures differently from similarly titled measures used by other companies.  Therefore, our non-GAAP financial measures may not be comparable to those used by other companies.  We have described the reconciliations of each of our non-GAAP financial measures described above to the most directly comparable GAAP financial measures.

We use this non-GAAP financial information, and in particular non-GAAP cash operating income (loss), for internal managerial purposes because we believe such measures are one important indicator of the strength and the operating performance of our business.  Analysts and investors frequently ask us for this information.  We believe that they use this information to evaluate the overall operating performance of companies in our industry, including as a means of comparing period-to-period results and as a means of evaluating our results with those of other companies.

Our non-GAAP cash operating income, excluding non-cash expenses, during the three months ended September 30, 2017 was approximately $1,025,000 and our non-GAAP cash operating income, excluding one-time costs, for the three months ended September 30, 2016 was approximately $1,444,000.

 

Our non-GAAP cash operating income, excluding non-cash expenses, during the nine months ended September 30, 2017 was approximately $2,437,000 and our non-GAAP cash operating income, excluding one-time costs for the nine months ended September 30, 2016 was approximately $2,712,000.