Item 1. Business
Company Background
Vision-Sciences, Inc. and its subsidiaries (the “Company,” which may be referred to as “our”, “us”, or “we”) designs, develops, manufactures, and markets products for endoscopy - the science of using an instrument, known as an endoscope - to provide minimally invasive access to areas not readily visible to the human eye. We have two reportable segments, medical and industrial. Each of these operating segments has unique characteristics and faces different opportunities and challenges. We were incorporated in Delaware, and are the successor to operations originally begun in 1987. In December 1990, we acquired Machida Incorporated (“Machida”) and it became our wholly-owned subsidiary.
Medical Business Segment
Our medical segment designs, manufactures, and sells our advanced line of endoscopy-based products, including our flexible fiber and video endoscopes and our EndoSheath technology, for a variety of specialties and markets. Our proprietary reusable, flexible endoscope is combined with a single-use, sterile protective EndoSheath disposable that is placed over the patient contact area of the scope. Our “always sterile” EndoSheath technology reduces the risks of cross-contamination associated with the reuse (or “reprocessing”) of conventional endoscopes, which are difficult, costly, and time-consuming to clean and disinfect or sterilize.
In November 2012, the ECRI Institute listed cross-contamination from flexible endoscopes as the eighth most dangerous hazard on its list of the top-ten health technology hazards for 2013. The use of our EndoSheath technology allows healthcare providers to perform a rapid, simplified reprocessing routine after use, avoiding the elaborate high level disinfection/sterilization routines required by the U.S. Food and Drug Administration (the “FDA”) for conventional endoscopes. The FDA requires that all conventional flexible endoscopes be reprocessed according to FDA-cleared manufacturers’ regulations and organizational guidelines, whether they are used in hospitals, clinics or office settings. With our EndoSheath technology we are able to reduce the steps needed to reprocess flexible endoscopes from approximately 27 to three, thereby saving time and lowering costs. This design of “always ready” equipment, which allows for a rapid and less damaging cleaning process, provides a multitude of benefits to healthcare practitioners, such as lower capital equipment investment, less service and maintenance costs of capital equipment, less staff exposure to toxic chemicals, increased patient scheduling flexibility and throughput, improved staff productivity and a more practical implementation of endoscopy.
We target six market spaces for our endoscopes and our EndoSheath technology:
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Urology - we supply our cystoscopes, ureteroscopes, and EndoSheath technology to the Endoscopy Division of Stryker Corporation (“Stryker”) in North and Latin America, South America, China and Japan. Although Stryker was to receive the exclusive rights for the rest of the world in April 2012, we reached an agreement with them to delay this launch indefinitely. Until we agree with Stryker on the date of such launch, we will continue to manufacture and sell our cystoscopes and EndoSheath technology to our independent distributors for sale in the rest of the world.
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Critical Care / Pulmonology - we manufacture, market, and sell our bronchoscope (an endoscope that allows detailed viewing of the lungs) and EndoSheath technology to intensivists, pulmonologists, thoracic surgeons, and other airway-related physicians.
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Surgery - we manufacture, market, and sell our TNE (trans-nasal esophagoscopy) endoscope and EndoSheath technology to general surgeons, primarily bariatric and gastroesophageal reflux disease (“GERD”) surgeons.
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Gastroenterology - we manufacture, market, and sell our TNE endoscopes and EndoSheath technology to gastroenterology (“GI”) physicians, ear, nose, and throat (“ENT”) physicians and others with a GI focus as part of their practice.
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ENT (ear, nose, and throat) - we manufacture, market, and sell our ENT endoscopes to ENT physicians.
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Spine - we supply our flexible video surgical endoscope systems to SpineView, Inc. for use with SpineView’s space creator product.
Industrial Business Segment
Our industrial segment, through our wholly-owned subsidiary Machida, designs, manufactures, and sells borescopes to a variety of users, primarily in the aircraft engine manufacturing and aircraft engine maintenance industries. A borescope is an instrument that uses optical fibers for the visual inspection of narrow cavities. Our borescopes are used to inspect aircraft engines, casting parts and ground turbines, among other items.
Machida’s quality line of borescopes includes a number of advanced standard features normally found only in custom designed instruments. We were the first to offer a flexible borescope with a grinding attachment, allowing users to “blend” or smooth small cracks in turbine blades of jet engines without disassembling the engine, saving our customers significant expense and delay.
Business Strategy
We believe our technology delivers significant value to doctors, clinics, and hospitals through reduced capital, lower staff and service costs, and increased patient throughput, practice revenue, and profitability. We strive to be a customer-centric organization with a focus on enhancing stockholder value. We are doing this by:
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Increasing the size and capabilities of our sales force in the U.S. by adding proven medical-surgical device sales professionals in promising territories;
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Targeting acute care facilities and office-based clinics that recognize patient safety and the patient experience as a primary value position;
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Capitalizing on our extensive and relevant library of published clinical studies on the efficacy and safety of our EndoSheath technology; and
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Enhancing our professional educational programs to enable healthcare professionals to teach other healthcare professionals about our EndoSheath technology.
Products
We have developed two visualization platforms for flexible endoscopy: fiber optic (4000 Series) and video (5000 Series and 7000 Series). Our 4000 Series fiberscopes contain advanced fiber optic imaging systems with high quality functional aspects, such as small diameter endoscopes and portability options, through the use of a battery-powered light source. Our lightweight, advanced, digital video-based endoscopes facilitate diagnostic and therapeutic procedures. Our small diameter videoscopes contain a high resolution, tiny CCD camera at the tip of the scope, offering a sharp, vibrant, full screen image. The 7000 Series and 5000 Series video endoscopes also feature pioneering functional aspects, including the elimination of an external light source, the inclusion of an integrated light emitting diode (LED), industry leading small diameter sizes and robust durability. Four programmable buttons located on the control body (handle) of the endoscope allow for immediate operation of the various functions our video system is capable of performing.
Our 7000 Series and 5000 Series videoscopes are powered by our multi-functional digital processing unit (“DPU”). Unlike conventional endoscopy towers we have integrated key peripherals into this unit, which allows one touch image archiving via an integrated SD card system. Users can easily move images captured during various endoscopic procedures to patient files for future viewing. Our liquid crystal display or LCD provides full screen presentation with no truncation (framing) of image, commonly seen in other videoscope manufacturer’s products. Our DPU maintains a smaller footprint than its competitors. Along with EndoSheath technology, our DPU contributes significantly to portability by allowing bedside procedures where space is limited. Additionally, the DPU is easily transported from facility to facility allowing physicians to perform video endoscopy in even the most remote of locations.
We developed two models of our DPU, the 5000 Series and the 7000 Series. In addition to the features noted above, our 5000 Series processor provides customers with a powerful, efficient, and easy-to-use system that has vibrant, high-resolution imaging.
Our recently launched 7000 Series DPU includes a new, simplified user interface, programmable user preference controls, expanded on-screen notifications, and easy-to-maintain patient lists, all of which allow end-users to improve productivity and workflow by customizing the operation of the system to the day-to-day needs of the practice. Additionally, the system incorporates a “one-touch” integrated keyboard to ensure quick activation of functions, including full control of video playback options, such as frame-by-frame review or historical image comparison, both of which are ideal for patient progress review.
The following table summarizes the primary products we sell in each market space and the distribution network we use to market and sell those products:
* North America, South America, Latin America, China, and Japan
EndoSheath Technology
We have developed EndoSheath technology for use with our proprietary endoscopes. EndoSheath technology is made with materials using our proprietary process that makes the sheath lubricious (smooth), allowing the healthcare practitioner to easily slide and place the EndoSheath disposable onto the endoscope. In addition, our EndoSheath technology has an optically clear window that fits securely over the endoscope tip, providing a clear image. Once installed, the disposable sheath offers a complete barrier between the endoscope and the patient. After the procedure is completed, the sheath easily slides off and is removed from the endoscope and discarded.
Our EndoSheath technology offers various size working channels, unlike conventional flexible endoscopes, which have the working channel inside the endoscope itself, allowing our users to customize the scope to the procedure (i.e. diagnostic cystoscopy, which requires a small working channel, or therapeutic cystoscopy, which requires a larger working channel). This enables us to provide procedure-specific EndoSheath technology without requiring physicians to purchase a new endoscope for a different procedure.
Our EndoSheath technology offers these key advantages:
”Always Sterile” Endoscope. Our “always sterile” EndoSheath technology is a durable, microbial barrier that prevents direct contact between the reusable endoscope and the patient. Furthermore, the working channel is part of the sheath and carries all the patient tissue material, such as biopsies and aspirated patient fluids. We believe this technology significantly reduces the risk of cross-contamination.
Increased Productivity. As the use of flexible endoscopy becomes more prevalent, the ability to perform more procedures in a given day has become paramount. Because a flexible endoscope utilizing the EndoSheath technology does not have to undergo the same complex and time-consuming reprocessing routines as conventional endoscopes, the endoscope is ready for the next procedure in typically ten minutes or less, versus 45 minutes to up to 24 hours with conventional endoscopes. Our EndoSheath technology allows a physician the opportunity, with a single endoscope, to perform upwards of 25 procedures in an eight hour day. This allows for higher patient throughput and increased physician and facility revenue. We believe that the ability to have a flexible endoscope that is “always ready” provides a unique opportunity to any healthcare facility setting that may see additional patients sent to their practice throughout the day.
Less Capital Costs. Because an endoscope using EndoSheath technology is essentially ready at a moment’s notice, physicians do not have to invest in the extensive inventory of conventional endoscopes necessary to operate a practice. In very busy hospital endoscopy suites, clinics and physician practices, this capital savings may be significant. Furthermore, our EndoSheath technology allows a single scope to be configured for different applications (i.e. diagnostic or therapeutic) depending on which EndoSheath disposable model is placed over the endoscope. This ability to configure our endoscope with different EndoSheath models further allows healthcare facilities to limit their capital expense by avoiding the need for multiple specialty endoscopes.
Less Maintenance Costs. Because an endoscope using EndoSheath technology does not undergo the rigorous, caustic reprocessing routines that a conventional flexible endoscope must receive, the endoscopes may experience fewer repairs and have a longer useful life. Additionally, many scope repairs occur due to damage to the working channel, which requires extensive brushing and flushing during the manual cleaning phase. Since our endoscopes’ working channels are in the disposable sheath there is never a need for channel-based repairs.
Facilitates Procedures in Outpatient and Office Settings. Since our endoscopes using EndoSheath technology do not need to be reprocessed with conventional caustic and toxic chemicals, physicians can easily perform procedures in their offices. Using our EndoSheath system, physicians can provide safe endoscopy without elaborate reprocessing equipment and additional staff. Furthermore, physician reimbursement is typically higher in an office or outpatient setting than in the hospital.
Enhanced Safety. According to a survey by the Environmental Working Group in December 2007, “…health care workers are still inhaling and absorbing unknown amounts of glutaraldehyde, in common disinfection procedures, at facilities all over the country.” Our endoscopes using EndoSheath technology do not require reprocessing with glutaraldehyde or similarly toxic chemicals between procedures, dramatically reducing the exposure to healthcare workers, specifically nurses.
Urology
Urology Endoscope Technology
We developed unique products for urology with our fiber and video cystoscopes, both utilizing our EndoSheath technology. We differentiate our cystoscopy system in a clinical setting by referring to the procedures using our system as EndoSheath cystoscopy.
Our cystoscopes consist of two components - a reusable flexible endoscope incorporating our proprietary design, and a proprietary, sterile EndoSheath disposable. The EndoSheath disposable slides easily onto the cystoscope; it includes a covering for the endoscope and a working channel, which may be used for irrigation, suction and therapeutic tool delivery as well as a covering over the control body (handle), where the physician operates the cystoscope. The EndoSheath is the only component that comes into contact with the patient, and is discarded after each procedure.
Our visualization platform includes our line of advanced digital, video-based flexible cystoscopes, the CST-5000, which utilizes our EndoSheath technology. The CST-5000 is a CCD-based video imaging endoscopy system, which includes an integrated built-in LED light source and operates with our all-in-one DPU. We also market and distribute a fiber optic cystoscope, the CST-4000, which utilizes our EndoSheath technology as well.
We also developed a video-based flexible ureteroscope, the URT-7000, for Stryker. This endoscope gives surgeons unsurpassed high-definition visualization of the ureters and kidneys with up to 240o of articulation allowing access to the most difficult locations of the kidney. The URT-7000 features an integrated LED, which eliminates the need for a separate light source.
Urology EndoSheath Technology
We offer urologists two sheath models for each of our fiber and video cystoscopes: a diagnostic sheath with a 1.5mm working channel size that provides enhanced patient comfort, and a therapeutic sheath with a larger, 2.1mm working channel size that provides the same capabilities as conventional cystoscopes.
Pulmonology / Critical Care
Pulmonology Endoscope Technology
We market and sell products for pulmonology and airway management using our fiber and video bronchoscopes. Our bronchoscopes utilize our EndoSheath technology and are inserted down the mouth and into the lungs, providing visualization of the lungs and the ability to perform a variety of diagnostic and therapeutic procedures. Our visualization platform includes our line of advanced digital, video-based flexible bronchoscopes, the BRS-5000, which incorporates our EndoSheath technology, as well as a fiber optic bronchoscope, the BRS-4000. The BRS-5000 is a CCD-based video imaging endoscopy system, which includes an integrated built-in LED light source and operates with our all-in-one DPU.
Pulmonology EndoSheath Technology
We market and distribute four sheath models for video and fiber bronchoscopy: a 1.5mm working channel, a 2.1mm working channel, a 2.8mm working channel (outside of the U.S.), and one without a working channel. We are currently seeking approval to market the 2.8mm channel in the U.S. The multiple sizes are necessary due to various procedures that are performed by pulmonologists and airway management physicians. Depending on the type of procedure in the airways, a pulmonologist or airway management physician may use a very small diameter EndoSheath disposable, with or without a working channel, or a larger diameter EndoSheath disposable with a working channel.
Gastroenterology and Surgery
GI and Surgery Endoscope Technology
We developed advanced digital, video-based flexible TNE endoscopes, the TNE-5000, which utilizes our EndoSheath technology. The TNE-5000 is a CCD-based video imaging endoscopy system, which includes an integrated built-in LED light source and operates with our all-in-one DPU. This streamlined video-based system eliminates the need for a separate camera head, light source and video monitor, as well as the need for the physician to perform the entire procedure looking through an eyepiece, a practice no longer acceptable in gastroenterology.
GI and Surgery EndoSheath Technology
We market and distribute two sheath models for the video TNE: a diagnostic sheath with a 1.5mm working channel size, and a therapeutic sheath with a 2.1mm working channel size. This unique feature of our EndoSheath technology provides gastroenterologists, ENT physicians, bariatric surgeons and others with two choices: a diagnostic sheath with a smaller sheath diameter (due to a smaller working channel) for patient comfort, and a therapeutic sheath with a larger working channel, providing the same capabilities as conventional endoscopes.
ENT (Ear, Nose, and Throat)
ENT Endoscope Technology
We developed unique products for urology with our fiber and video laryngoscopes, which we refer to as ENT scopes. Our visualization platform includes our line of advanced digital, video-based flexible ENT scopes, the ENT-5000. The ENT-5000 is a CCD-based video imaging endoscopy system, which includes an integrated built-in LED light source and operates with our all-in-one DPU.
We also developed two fiber optic ENT scopes, the ENT-4000 and the ENT-4500. The ENT-4500 is a small diameter fiber laryngoscope primarily used for small cavity and pediatric procedures.
Our fiber and video ENT scopes can be used with or without the EndoSheath technology, as they do not feature any working channels and are diagnostic only.
Spine
Surgical Endoscope Technology
Our visualization platform is a key enabling technology for SpineView as we believe it revolutionizes the minimally invasive surgery (“MIS”) spine market. Based on industry sources, we estimate that the MIS spine market is approximately $1 billion and growing at a compound annual rate of approximately 15%. We designed a 2.0mm charge-coupled device (“CCD”) based video surgical endoscope exclusively for SpineView. In December 2012, SpineView received 510(k) clearance from the FDA to market their camera system, which incorporates our 2.0mm flexible endoscope. SpineView is currently in clinical preference trials and conducting training labs prior to surgeons doing actual cases.
Industrial
Borescopes
Our borescopes are constructed in a variety of body types, including portable models, each specifically designed to cover a multitude of needs and applications:
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Modular (MBS) - borescope with diameter range from 0.6mm to 2mm, Machida’s smallest body type.
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Slim Lever - borescope with diameter range from 2mm to 6mm and providing angulations in two directions. This is Machida’s most widely used body type and includes high quality optics and illumination.
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Knob - borescope with diameter range from 8mm to 11mm. This four-way, ambulating scope is particularly suited for longer (up to 20 feet) borescopes. It comes in different configurations, including direct view with different types of covers, side views, with a working channel and with a permanent side-view option.
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Battery Operated Portable Flexible Borescope - borescope with small battery handle; it is ideal for field inspections. The borescope kit includes the scope, light guide and sleeve, a light source, battery and handle, and a carrying case.
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Industrial Videoscope - 3mm video borescope product line, the smallest diameter videoscope offered in the industrial market. The video borescope uses a CCD-based video system, which includes an integrated built-in LED light source and operates with our streamlined, multi-functional processor.
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Portable Video Processor - digital processing unit, which works with the industrial videoscope, allows for portability and accessibility in constrained areas, a common situation in the aviation field.
Recent Product Launches
In December 2012, we began to exclusively supply to Stryker our first charge-coupled device (CCD) based flexible ureteroscope. This ureteroscope expands our new 7000 Series video endoscopy platform and is the smallest CCD-based video endoscope in the marketplace today. Ureteroscopes are used for diagnostic and therapeutic procedures in the ureter and the kidney, typically performed in a hospital operating room setting.
We also launched our next-generation digital video processor, the DPU-7000, in fiscal 2013. This integrated visualization endoscopy platform is a high-performance, efficient, and easy-to-use system designed to provide expanded benefits across a broader spectrum of users. The DPU-7000 is the first all-in-one endoscopy platform to include audio, video, archiving, and workflow enhancements in a single standalone unit. It is fully compatible with our 5000 Series line of endoscopes that utilize our EndoSheath technology.
In fiscal 2012, we launched a new “small diameter”, 2.4mm 4000 Series fiberscope, the ENT-4500, and the second generation of our 5000 Series video processor, which features upgraded software providing our customers with additional features and superior image quality.
Markets and Distribution
The end users of our endoscopy systems, our EndoSheath technology and related products primarily consist of urologists, pulmonologists, and other airway management doctors, gastroenterologists, bariatric surgeons, and ENT doctors in hospitals, medical clinics, and physicians’ private offices. Our medical devices may also be used by other physicians performing the procedures in alternate settings.
We market and distribute our medical segment products worldwide through a direct sales force in the U.S., a network of distributor organizations outside of the U.S., and strategic partners. In the U.S., we have a direct sales force and strategic partners for our urology (Stryker) and spine (SpineView) product lines. Internationally, we utilize regional or national distributors, who market and distribute all of our products. Stryker also has the exclusive right to market and sell our urology products in Canada, Latin America, South America, China, and Japan. Most of our distributors outside the U.S. also market and distribute products of other companies.
Our borescopes are sold directly by our Machida subsidiary and through a global network of independent sales representatives.
We regularly evaluate the effectiveness of all our sales channels, and may change them if we believe a different method would increase our revenues.
Sales to Major Customers
Medical Segment
Net sales to customers outside of the U.S. in our medical segment were approximately $4.4 million (29% of total net sales) and $4.5 million (27% of total net sales) for fiscal years 2013 and 2012, respectively.
In fiscal 2013, net sales to Stryker were approximately $3.1 million, representing 20% of our total net sales and 26% of our total medical segment net sales. Fiscal 2012 net sales to Stryker were $4.3 million, representing 26% of our total net sales and 31% of our total medical segment net sales.
Industrial Segment
Net sales to customers outside of the U.S. in our industrial segment were approximately $0.6 million (4% of total net sales) and $0.9 million (5% of total net sales) for fiscal years 2013 and 2012, respectively.
In fiscal 2013, net sales to Pratt & Whitney, a division of United Technology Corporation, were approximately $0.9 million, representing 6% of our total net sales and 26% of our total industrial segment net sales. Fiscal 2012 net sales to Pratt & Whitney were $0.1 million, representing 1% of our total net sales and 5% of our total industrial segment net sales.
Backlog
We had an order backlog of approximately $1.7 million at March 31, 2013 and 2012.
Manufacturing
Disposables (EndoSheath Technology)
We currently manufacture our EndoSheath line of disposable sheaths at our Natick, Massachusetts (“Natick”) facility using raw materials, molded parts, and components purchased from independent vendors, some of which are manufactured to our specifications. We also design and build our own production machines and tools. Our EndoSheath technology line includes products for all medical markets we currently serve.
Most components we purchase are available from multiple sources, with the exception of certain key components that are supplied to us by key suppliers, with whom we have long-term supply arrangements, but no long-term supply agreements. We purchase our required components and supplies on a purchase order basis and seek to maintain adequate inventory levels of such components to prevent supply disruptions. We contract with third parties for the sterilization of all of our EndoSheath disposables.
Fiberscopes, Videoscopes, Borescopes, and Peripherals
We manufacture our flexible endoscopes for the medical and industrial segments at our Orangeburg, New York (“Orangeburg”) facility, using purchased components and subassemblies, as well as certain proprietary components we or our subcontractors produce. Some purchased components and subassemblies are available from more than one supplier. For most of our purchases, we have no long-term agreements with our vendors or suppliers, and we purchase our required components and supplies on a purchase order basis. For certain critical components we have long-term supply arrangements, such as with Applitec LTD, which is based in Israel.
Research & Development (“R&D”)
We believe that our future success depends in part upon our ability to develop new products and enhance our existing products. We plan to continue investing resources in research and development to maintain a healthy and robust product pipeline. Our R&D expenses in fiscal years 2013 and 2012 were approximately $1.8 million and $3.2 million, respectively, representing 12% and 19% of total net sales, respectively.
With respect to our industrial segment, our ability to custom design for specific applications is common practice in our business. On-wing inspections with blending borescopes have become an indispensable tool for aircraft engine manufacturers and service providers. We are developing a tungsten braid videoscope with enhanced durability. We work closely with Pratt & Whitney, GE, Rolls Royce, and others to ensure production of the most efficient borescopes for their applications.
Third-Party Reimbursement
Hospitals, medical clinics, and physicians’ offices that purchase medical devices, such as our EndoSheath technology and flexible endoscopes, generally rely on third-party payors, such as Medicare, Medicaid and private health insurance plans, to pay for some or all of the costs of the screening, diagnostic and therapeutic procedures performed with these devices. Whether a particular procedure qualifies for third-party reimbursement depends upon factors such as the safety and effectiveness of the procedure, and reimbursement may be denied if the medical device used is experimental or was used for a non-approved indication. We believe, based upon our knowledge and experience of third-party reimbursement practices, and advice from consultants in this area, that third-party reimbursement is available for most procedures that utilize our products. However, most third-party payors do not reimburse health-care providers separately for the cost of our EndoSheath technology.
Third-party payors use a variety of mechanisms to determine reimbursement amounts for procedures such as endoscopies. In most cases, payment is based upon amounts determined by the Centers for Medicare & Medicaid Services (“CMS”), a governmental agency under the U.S. Department of Health and Human Services. As part of its responsibilities, CMS assigns relative value units (“RVUs”) to over 10,000 physician services. An RVU for a specific procedure is comprised of values for work, practice expense and malpractice insurance, and when multiplied by a conversion factor, represents a dollar value for a specific procedure.
CMS has multiple fee schedules to accommodate payment to the hospital, the ambulatory surgery center (“ASC”), and the physician. Physician services are reimbursed based on where the service is performed. If the physician performs the service in his or her office and the office bears the burden of overhead costs, the physician is reimbursed based on non-facility RVUs to accommodate the overhead costs. If the physician performs the service in a hospital or ASC, the payment is lower, reflecting the physician work and malpractice expenses, but without the overhead since the facility bears that financial burden. As it relates to our procedures, the calendar 2013 physician fee schedule did not change significantly from calendar 2012, and there was little change in hospital outpatient payments under Medicare. Based upon a review of calendar year 2012, fee schedules for the hospital outpatient and physician payment for procedures that utilize our EndoSheath technology with our TNE endoscope, physicians will receive between approximately 108% and 149% more by performing procedures in their offices than if they performed those procedures in hospitals, as a result of the increased office expense for the purchase of the device. For a diagnostic cystoscopy, physicians will receive approximately 63% more by doing the procedure in their offices, than if they performed that procedure in the hospital, again because the increase in fee accommodates the cost of the device purchased by the physician practice.
We believe that the number of procedures performed in non-facility settings will increase, primarily as a result of the increased differential in payments that physicians will receive for performing these procedures outside of hospital, or ASC. However, as these procedures move to non-facility settings, physicians will have to contend with the cost and effort required to reprocess conventional endoscopes. We believe our EndoSheath technology will provide an economically beneficial alternative to the use of endoscopes based upon the provider not having to purchase multiple endoscopes or expensive disinfecting equipment and supplies, and not having to spend valuable time cleaning endoscopes. We believe that with approximately 80 million people in the U.S. over the age of 50, the number of endoscopic procedures that physicians will perform will increase. We believe our EndoSheath technology, combined with the resource-based system for setting values for physician services, represents a sound economic solution for physicians to perform diagnostic and therapeutic procedures in their offices.
Quality and Regulatory
FDA Clearance and Global Regulatory Approvals
The medical products that we currently market and which we are developing are regulated as medical devices by the FDA under the federal Food, Drug and Cosmetic Act (the “FDC Act”) and require regulatory clearance prior to commercialization in the U.S. Under the FDC Act, the FDA regulates clinical testing, manufacturing, labeling, distribution and promotion of medical devices in the U.S. Various states and other countries in which our products are currently sold or may be sold in the future may impose additional regulatory requirements.
Flexible endoscopes and accessory products have been classified by the FDA as Class II devices and EndoSheath technology products have been classified by the FDA as class II sterile devices, and a Section 510(k) Pre-market Notification must be submitted to and cleared by the FDA before such devices can be sold. We have received FDA clearance of our 510(k) Pre-market Notifications for all of our products that require clearance with the exception of the bronchoscope 2.8mm EndoSheath disposable, for which we are currently seeking FDA approval. We expect that we will be required to obtain 510(k) Pre-market Notifications for each additional endoscope that we develop in the future.
Foreign government regulations vary substantially from country to country. The time required to obtain approval by a foreign country may be longer or shorter than that required for FDA approval, and the requirements may differ significantly.
Under the Canadian Medical Devices Regulations, all medical devices are classified into four classes, Class I being the lowest risk class and Class IV being the highest risk. Class I devices include among others, devices that make only non-invasive contact with the patient. Classes II, III and IV include devices of increasingly higher risk as determined by such factors as degree of invasiveness and the potential consequences to the patient if the device fails or malfunctions. Our current products sold in Canada generally fall into Classes I and II. All Class II, III and IV medical devices must have a valid Medical Device License issued by the Therapeutic Products Directorate of Health Canada before they may be sold in Canada (Class I non-sterile devices require only an establishment license, which we have obtained and maintain on an annual basis). We have obtained applicable Medical Device Licenses in Canada for all of our currently marketed products.
The European Union has adopted legislation, in the form of directives to be implemented in each member state, concerning the regulation of medical devices within the European Union. The directives include, among others, the Medical Devices Directive that establishes standards for regulating the design, manufacture, clinical trials, labeling, and vigilance reporting for medical devices. We have received CE (Conformité Européne) certification from Underwriters Laboratories UK for conformity with the European Union Medical Devices Directive allowing us to use the CE mark on our product lines currently sold in Europe. No additional pre-market approvals in individual European Union countries are required prior to marketing of a device bearing the CE mark.
Quality Standards
In August 2005, our Natick quality system certification was updated to establish conformance with ISO 13485: 2003 and continued conformance with Medical Devices Directive (“MDD”) 93/42/EEC and the Canadian Medical Device Regulations (“CMDR”).
In April 2007, our Orangeburg facility successfully completed an expansion audit and we were awarded International Organization for Standardization (“ISO”) 13485: 2003 certification for this location. This certification allowed us to start shipping scopes from our Orangeburg facility, in addition to shipments from our Natick facility. The Natick and Orangeburg facilities are registered with the FDA as medical device manufacturers. As a result, these facilities are subject to the FDA’s Quality System Regulations (“QSR”), which regulate their design, manufacturing, testing, quality control, and documentation procedures. We are also required to comply with the FDA’s labeling requirements, as well as its information reporting regulations.
The export of medical devices is also subject to regulation in certain instances. Our compliance with these various regulatory requirements is monitored through periodic inspections by the FDA and audits by independent authorities to maintain our ISO 13485, CMDR and MDD status. We routinely update our systems to comply with changes to applicable regulations such as the recent changes to the MDD, as amended by 2007/47/EC. In April 2013, the Orangeburg facility underwent a successful routine FDA audit with only minor observations.
In addition to the three-year ISO certification audits, we undergo annual surveillance audits to confirm that we are maintaining our quality system. This quality system has been developed in accordance with the International Organization for Standardization to ensure that companies are aware of the standards of quality to which their products will be held worldwide.
Unlike our medical segment, the manufacturing of our Machida industrial scopes is not subject to direct government regulation.
Business Development
Exclusive Urology Supply Agreement with Stryker
On September 22, 2010, we signed a three-year agreement under which we became the exclusive supplier to Stryker of Stryker-branded flexible video and fiber cystoscopes and video ureteroscopes. These cystoscopes employ our patented EndoSheath technology, which are co-branded Stryker and Vision-Sciences. Stryker has the exclusive rights to distribute these urology products in North and Latin America, South America, China and Japan. Stryker launched these product lines during April 2011 and introduced them at the American Urological Association annual meeting in May 2011.
The purchase price for the products is based on our cost to manufacture plus a margin specified in the Stryker Agreement. We recognize revenue for products sold to Stryker in a two-step process. The first step is recognition of revenue for our cost to manufacture these products when title passes to Stryker, generally upon shipment of our products F.O.B. shipping point. The second step is recognition of revenue for our specified margin of Stryker’s gross profit after Stryker sells the products to its end customers, based upon reports received from Stryker monthly. There is no cost of sales associated with revenue under this second step. There is no required minimum amount of scopes and EndoSheath products that Stryker is required to purchase from us.
We received a prepayment from Stryker of $5 million, of which we received $2.5 million at signing and the balance in March 2011. The prepayment was recorded as an advance from customer in our consolidated balance sheet. During fiscal 2012, we recognized $4.3 million in revenue for delivery of cystoscopes and EndoSheath technology, and the remaining balance of $0.1 million in fiscal 2013. After applying the final amount due from Stryker for purchases of scopes and EndoSheath technology to the prior advance, we began to receive cash payments from Stryker for products supplied.
Competition
We believe that the primary competitive factors in the medical market for flexible endoscopes include safety and effectiveness, the optical quality of product offerings, product reliability, price, physician familiarity with the manufacturer and its products, ease of use and third-party reimbursement policies.
Our ability to compete is directly affected by several factors, such as our sales and marketing capabilities, our product development and innovation capabilities, our ability to obtain required regulatory clearances, our ability to protect the proprietary technology which our products are based upon, our manufacturing skills and our ability to attract and retain skilled employees.
We believe our proprietary EndoSheath technology platform currently allows us a significant differentiating factor from our competition. Currently, all our competitors sell endoscopes that require elaborate and time-consuming reprocessing procedures.
Our current and future product lines face global competition, primarily from companies such as Olympus, Pentax, and Karl Storz. Some of our competitors and some potential competitors may have greater financial resources, experience, sales and marketing personnel and capabilities, research and development, and manufacturing personnel and capabilities than we do. In addition, any company that is able to significantly redesign conventional flexible endoscopes to simplify or significantly improve their reprocessing, may result in competition for our products.
In our industrial markets, we believe that our over 35 year history of product effectiveness, ease of use, product reliability and competitive pricing are the principal competitive factors to our success. Among our competitors are Olympus, Lenox, and Karl Storz Industrial.
Product Liability Insurance
The nature of our products exposes us to significant product liability risks. We believe that our level of coverage is appropriate, given our business, products, past sales levels and our anticipated sales levels for fiscal 2014. We evaluate the adequacy of our coverage periodically to determine if adjustments should be made.
Environmental Regulation
Our operations are regulated under various federal, state, and local laws governing the environment, including laws governing the discharge of pollutants into the air and water, the management and disposal of hazardous substances and wastes, and the clean-up of contaminated sites. We have infrastructures in place to ensure that our operations are in compliance with all applicable environmental regulations. We do not believe that costs of compliance with these laws and regulations will have a material adverse effect on our capital expenditures, operating results, or competitive position.
Patents, Intellectual Property and Licensing
We seek to establish and maintain our proprietary rights in our technology and products through the use of patents, copyrights, trademarks and trade secret laws. We routinely file applications for and obtain patent, copyright and trademark protection in the U.S. and in selected foreign countries, where we believe filing for such protection is appropriate. We also seek to maintain our trade secrets and confidential information by nondisclosure policies and through the use of appropriate confidentiality agreements. Our success depends in part on our ability to maintain patent protection for our products, to preserve our trade secrets and to operate without infringing the proprietary rights of third parties. Our strategy includes a vigorous protection of our current proprietary rights, as well as actively developing new proprietary innovations that strengthens our place in the markets for the future with additional patents and intellectual property. If we lose our patent rights or they expire, it could have a material adverse effect on our business.
Patents
We hold 19 U.S. patents, and we have 10 U.S. patent applications pending. In addition, we have 15 foreign patents issued and have 7 foreign patent applications pending. These patents relate to disposable sheaths for endoscopes and reusable flexible endoscopes, as well as other various products, endoscopy and non-endoscopy related. The issued patents will expire on various dates in the years 2013 through 2023.
Trademark Property
Vision-Sciences, Inc. owns the following U.S. trademarks, EndoSheath®, EndoWipe®, The Vision System®, Vision Sciences™ and Slide-On™.
Employees
As of March 31, 2013, we had 108 employees, of which 101 were full-time and 7 were part-time. None of our employees are represented by a labor union. We consider the relationships with our employees to be positive. Competition for technical personnel in the industry in which we compete is intense. We believe that our future success depends in part on our continued ability to hire, assimilate and retain qualified personnel.
Executive Officers of the Company
The following individuals were serving as executives of the Company as of June 7, 2013:
Howard I. Zauberman, age 60, was appointed our Interim Chief Executive Officer on May 13, 2013. Mr. Zauberman has over 30 years of experience as a leader in the medical products industry. Prior to joining us, from 2005 through 2012, Mr. Zauberman was Vice President of Business Development at Henry Schein, Inc., a leading global healthcare distributor serving office based medical practitioners. Mr. Zauberman also served as a Special Venture Partner at Galen Partners, a healthcare growth equity and late stage venture capital firm, focused on technology enabled services, medical devices and specialty pharmaceuticals. Prior to this, Mr. Zauberman held senior management positions at ETHICON, Inc. a Johnson & Johnson company and Pfizer, Inc. Mr. Zauberman has a Masters of Engineering Management from Northwestern University, a Bachelor of Science from Columbia University in mechanical engineering and a Bachelor’s degree from Queens College.
Lewis C. Pell, 60, is a co-founder of Vision-Sciences. On June 14, 2013, Mr. Pell was appointed by the Board of Directors as our Principal Executive Officer (“PEO”). We expects Mr. Pell will serve as the PEO until approximately June 30, 2013, after which Mr. Zauberman, the Company’s Interim Chief Executive Officer, is expected to assume the role of the Company’s PEO. Mr. Pell has been Chairman of the Board since 2005. Prior to that, Mr. Pell served as Vice-Chairman of our Board of Directors since 1992. Mr. Pell is a founder or co-founder and chairman and director of several privately held medical device companies and is the chairman of Photomedex, Inc., a publicly-traded dermatology company.
Keith Darragh, age 32, was appointed our Interim Principal Financial and Accounting Officer on June 12, 2013. Prior to this recent appointment, Mr. Darragh served as our Principal Financial and Accounting Officer from August 2012 until May 2013, and our Vice President of Finance from September 2011 until May 2013. Mr. Darragh joined us in August 2009 as Corporate Controller. Mr. Darragh’s prior experience includes serving as Director of Corporate Accounting and Financial Reporting at Datascope Corp., a publicly traded medical device manufacturer that was acquired by Getinge Group. Mr. Darragh also held positions of increasing responsibility in accounting and finance at SYMS Corp, Sankyo Pharma, Inc., and Genzyme Biosurgery Corp. Mr. Darragh is a certified public accountant and chartered global management accountant, and holds a B.S. (summa cum laude) and an M.B.A. from Montclair State University.
Mark S. Landman, age 58, has been our Vice President, Disposables Operations since 2007 and Vice President of our Medical Division since July 1999. Mr. Landman joined us from Boston Scientific in January 1991 and served in a variety of roles in product development, project management, manufacturing engineering, and material control from that date to July 1999.
Jitendra Patel, age 59, has been our Vice President, Industrial Division since August 2000. From August 1995 to July 2000, he served as the Manager of Sales and Marketing for that division.
Officers are elected on an annual basis and serve at the discretion of the Board of Directors.
Item 1A.
Item 1A. Risk Factors
You should carefully consider the risks and uncertainties we describe below and other information in this Annual Report before deciding to invest in, or retain, shares of our common stock. These are not the only risks and uncertainties that we face. Additional risks and uncertainties that we do not currently know about or that we currently believe are not material, or that we have not predicted, may also harm our business operations or adversely affect us. If any of these risks or uncertainties actually occurs, our business, financial condition, operating results or liquidity could be materially harmed.
We have a history of operating losses, we may not achieve or maintain profitability in the future, and we will require additional financing, which may not be available on acceptable terms or at all
We have incurred substantial operating losses since our inception and there can be no assurance that we will ever achieve or sustain a profitable level of operations in the future. We anticipate that we will continue to incur negative cash flows from operations during fiscal 2014, driven by continued investment in a direct sales force for the U.S. market, spending for marketing, and general business operations. As of March 31, 2013, we had cash and cash equivalents totaling approximately $0.8 million. We expect that our cash at March 31, 2013, together with the $3 million of capital available under a convertible note dated September 19, 2012 and $5.0 million of capital to be made available to us, subject to certain conditions, under a letter agreement dated June 21, 2013 from Lewis C. Pell, our Chairman (see Note 13. Subsequent Event for additional information), should be sufficient to fund our operations through at least March 31, 2014. However, if our performance expectations fall short (including our failure to generate expected levels of sales) or our expenses exceed expectations, we will need to reduce our expenses and/or secure additional funding to support our operational needs in the future, and we cannot be certain that such funding will be available on terms acceptable to us, if at all, particularly in light of current economic and capital market conditions for companies of our size. Any capital raising necessary to continue our operations may be through one or a combination of approaches, which could include public or private financing, issuances of equity or debt, sale or partnering of one or more of our assets or other strategic initiatives. Any public or private financings involving issuances of common stock or other classes of our equity would likely dilute existing stockholders’ percentage ownership. If we are unable to obtain funding to support operations, we will be forced to curtail our operations and we may be less likely to develop and market products successfully, which would have a material adverse impact on our prospects and financial condition. If required, we believe we would be able to reduce our expenses to a sufficient level to continue to operate as a going concern.
Our supply agreement with Stryker may not meet our expectations
Under our agreement with Stryker, we supply to Stryker our flexible video and fiber cystoscopes and related EndoSheath products for a term of three years after the launch of these products, which occurred in April 2011. We also supply Stryker with flexible ureteroscopes under the same agreement. This product was launched in December 2012 and carries the same three-year term as our cystoscopes and EndoSheath products. Stryker has the exclusive rights to distribute these products in North and Latin America, South America, China and Japan. There can be no assurance of the quantity of products Stryker will purchase from us or whether Stryker will succeed in marketing and selling these products. If they do not purchase products from us or are unsuccessful in marketing or selling these products, we will not be able to distribute those products to others and could generate little or no revenue from the Stryker agreement. There also can be no assurance that Stryker will agree to distribute our cystoscopes and related EndoSheath products beyond the current expiration of the existing agreement, beginning in April 2014.
Failure to obtain sourcing of critical components on acceptable terms will have a material adverse effect on our results of operations and financial condition
In our medical and industrial segments, certain components for our fiberscopes and videoscopes are generally only available from one source with which we do not have a short- or long-term agreement for purchases. Our inability to obtain any such parts could delay or prevent us from making and selling products, which would have a material and adverse effect on our financial condition and results of operations.
In addition, the success of our videoscope sales will depend in part on our ability to manufacture these videoscopes in sufficient quantities and with sufficient quality to meet customer demand. We do not have fixed long term supply agreements with our suppliers for components and subassemblies for our videoscopes. The failure or inability of one of these key suppliers to meet our production quantity and quality needs on terms that are acceptable to us, if at all, could have a material adverse effect on the sales of our videoscopes, their acceptance into the marketplace and our long-term prospects.
In our industrial segment, borescopes are assembled using components and subassemblies purchased from independent vendors. While most components and subassemblies are currently available from more than one supplier, certain critical components are currently purchased only from limited key suppliers with which we do not have long or short term contracts. Our failure to obtain a sufficient quantity of such components on favorable terms could materially adversely affect sales in our industrial segment.
If we fail to effectively manage our sales force or our distribution network, our business, prospects, and brand may be materially and adversely affected
We sell our products through a combination of a direct sales force and independent distributors. We have limited experience in managing a direct sales force and we cannot assure you that we will be able to build and grow an effective direct sales force or successfully develop our relationships with third-party, outside distributors. The expansion of our sales force and distribution network is requiring an investment of financial resources and management efforts, and the benefits, if any, which we gain from such expansion, may not be sufficient to generate an adequate return on our investment. If we fail to build and manage an effective direct sales force or successfully develop, maintain, and manage our relationships with distributors, our sales could fail to grow or could even decline and this would have a material adverse impact on our business and financial condition.
In addition, we have a limited ability to direct or influence the activities of our third-party independent distributors. Our distributors could take one or more of the following actions, any of which could have a material adverse effect on our business, prospects and brand:
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sell products that compete with our products in breach of their non-competition agreements with us;
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fail to adequately promote our products; or
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fail to provide proper service to our end-users.
If we are unable to adequately manage our distribution network, or if our distributors fail to meet their obligations under their agreements with us, our corporate image among end users of our products could be damaged, resulting in a failure to meet our sales goals. In addition, foreign governments have increased their anti-bribery efforts in the healthcare sector to reduce improper payments received by hospital administrators and doctors in connection with the purchase of pharmaceutical products and medical devices. To our knowledge, none of our distributors engages in corrupt practices. However, our distributors may violate these laws or otherwise engage in illegal practices with respect to their sales or marketing of our products which would adversely affect our corporate image and business.
Our failure to effectively expand our marketing efforts may materially and adversely affect our business, prospects, and brand
Our marketing efforts span five broad medical markets: urology, critical care / pulmonology, surgery, GI, and ENT. We cannot assure you that we will be able to build our brand effectively to our end users in each of the markets that we serve. If we do not succeed, our sales could fail to grow or could even decline, and our ability to grow our business could be adversely affected. The expansion of our marketing efforts will require an investment of financial resources and management efforts, and the benefits, if any, which we gain from such expansion, may not be sufficient to generate an adequate return on our investment.
We expect gross margins to vary over time, and our level of product gross margins may not be sustainable
The current levels of our product gross margins may not be sustainable and may continue to be adversely affected by numerous factors, including:
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introduction of new products;
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our ability to reduce supply and production costs;
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increases in material or labor costs;
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changes in shipment volume;
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loss of cost savings due to changes in component pricing, including the impact of foreign exchange rates for components purchased overseas;
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changes in distribution channels;
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increased warranty costs; and
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the uncertainty of the timing and amounts for recognizing our specified margin of Stryker’s gross profit after Stryker sells the products to their end customers.
Our costs could substantially increase if we experience a significant number of warranty claims or recall events
We provide 12-month product warranties against technical defects of our fiberscopes and videoscopes, and we offer a lifetime warranty for the LED light source on our videoscopes. Our product warranty requires us to repair defects arising from product design and production processes, and if necessary, replace defective components. Historically, we have received a limited number of warranty claims for our fiberscopes. The costs associated with our warranty claims have historically been relatively low. Thus, we generally do not accrue a significant liability contingency for potential warranty claims.
If we experience an increase in warranty claims, or if our repair and replacement costs associated with warranty claims increase significantly, we will begin to incur liabilities for potential warranty claims after the sale of our products at levels that we have not previously incurred or anticipated. An increase in the frequency of warranty claims or amount of warranty costs may harm our reputation and could have a material adverse effect on our financial condition and results of operations as could product efficacy or safety concerns, whether or not based on scientific evidence, resulting in product withdrawals, recalls, regulatory action on the part of the FDA (or international counterparts) or declining sales;.
We may not succeed in sustaining a market for our videoscopes
Going forward, the long-term success of our videoscope system depends on several factors, including:
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our ability to successfully promote product awareness of our videoscopes;
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our ability to manufacture products in a timely and cost effective fashion on acceptable terms;
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competitive pricing of our videoscopes and add-on components;
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our ability to develop new applications to expand our family of videoscopes;
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retaining and growing an effective direct sales force in the U.S.;
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selecting and managing effective distributors internationally;
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Stryker’s ability to sell our videoscopes to its end customers;
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obtaining additional regulatory approvals or clearances for new components or systems in a timely manner;
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the relative costs and reimbursement profile, and benefits of procedures using our videoscope system as compared to other procedures; and
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the financial or other benefits gained by doctors that use our videoscopes with our EndoSheath disposables.
Existing videoscope technology is a well-established method for obtaining clinical diagnoses. As a result, our videoscopes are competing in a market in which there are already several established industry players. We cannot assure you that we will be able to successfully market or sell our videoscopes in the future. We also cannot assure you that our videoscopes or any future enhancements to our videoscopes will generate adequate revenue to offset our investments and costs in acquiring, developing or marketing our videoscopes. If there is insufficient demand for our videoscopes, our business, financial condition and results of operations would be materially adversely affected. In addition, any announcement of new products, services or enhancements by us or our competitors may cause our customers to cancel or postpone purchasing decisions for our existing products in anticipation of these new products, services or enhancements.
Our stock price is volatile, and you may not be able to sell your shares for a profit
The trading price of our common stock is highly volatile. Our common stock price could be subject to fluctuations in response to a number of factors, including:
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actual or anticipated variations in operating results;
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conditions or trends in the medical device market;
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announcements by us or our competitors of significant customer wins or losses, gains or losses of distributors;
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technological innovations, new products or services;
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addition or departures of key personnel;
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actual or expected sales of a large number of shares of our common stock;
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adverse litigation;
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unfavorable legislative or regulatory decisions;
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variations in interest rates;
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general market conditions;
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availability of components on acceptable terms;
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availability of distributor arrangements on favorable terms; and
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any of the other factors described in these “Risk Factors”.
In addition, the stock market in general, the NASDAQ Capital Market, and the market for shares of novel technology and medical device companies in particular, have experienced extreme price and volume fluctuations that have often been unrelated or disproportionate to the operating performance of those companies. Further, the market prices of life science companies have been unusually volatile in recent years, and such volatility may continue for the foreseeable future. These broad market and industry factors may materially harm the market price of our common stock, regardless of our operating performance. In addition, this volatility and the low level of market liquidity for our common stock could adversely affect an investor’s ability to sell shares of our common stock and the available price for such shares, at any given time.
In the past, companies that have experienced volatility in the market price of their stock have been the target of securities class action litigation. We may become the target of this type of litigation in the future. Securities litigation against us could result in substantial costs and divert management attention, which could seriously harm our business.
The effects of the ongoing global economic slowdown may impact our business, operating results or financial condition
The ongoing global economic slowdown has caused a general tightening in the credit markets, lower levels of liquidity, increases in the rates of default and bankruptcy, and extreme volatility in credit, equity and fixed income markets. We believe these macroeconomic developments may negatively affect our business, operating results or financial condition in a number of ways.
For example, current or potential customers may be unable to fund endoscope and EndoSheath disposable purchases, which could cause them to delay, decrease, or cancel purchases of our products and services, or to not pay us or to delay paying us for previously purchased products. As a result, we may require more customers to purchase our products and services on a cash basis. In addition, any material adverse condition occurring with a supplier or distributor, including Stryker, would have a material adverse effect on our business.
Rapid growth and a rapidly changing operating environment may strain our limited resources
Our growth strategy includes our efforts to increase our marketing and sales efforts to build our revenues and brand, develop new products, and increase market penetration of our videoscopes. This growth strategy requires significant capital resources, and we may not generate an adequate return on our investment. Our growth may involve the acquisition of new technologies, businesses, products or services, or the creation of strategic alliances. This could require our management to develop expertise in new areas, manage new business relationships and attract new types of customers. We may also experience difficulties integrating any acquired businesses, products or services into our existing business and operations. The success of our growth strategy also depends in part on our ability to utilize our financial, operational and management resources and to attract, train, motivate and manage an increasing number of employees. The success of our growth strategy depends on a number of internal and external factors, such as:
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the growth of our addressable market for medical devices and supplies;
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availability of capital;
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the availability and levels of reimbursement by third-party payors to physicians for each of our medical products;
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ability to maintain patents and other proprietary rights;
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the effectiveness of our direct sales force in the U.S.;
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our ability to simultaneously develop and enhance a new line of fiber-based scopes and expand our videoscope family;
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increased customer awareness and acceptance of our products;
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continued enhancement of our research and development capabilities;
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competition from other manufacturers of similar devices; and
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competition from other companies that offer these products.
We may not be able to implement our growth strategy successfully or manage our expansion effectively. Further, as we ramp up our manufacturing operations to accommodate our planned growth, we may encounter difficulties associated with increasing production scale, including shortages of qualified personnel to operate our equipment, assemble our products or manage manufacturing operations, as well as shortages of key raw materials or components for our products. In addition, we may also experience difficulties in producing sufficient quantities of products or in achieving desired product quality. If we are unable to successfully operate and manage our manufacturing operations to meet our needs, we may not be able to provide our customers with the quantity or quality of products they require in a timely manner. Any loss of customers may result in reduced product sale revenues and could have a material adverse effect on our business.
Our inability to continue to hire and retain key employees could have a negative impact on our future operating results
Our success depends on the services of our senior management team and other key employees in our research and development, manufacturing, operations, accounting, and sales and marketing departments. If we are unable to recruit, hire, develop and retain a talented, competitive work-force, we may not be able to meet our strategic business objectives. In May 2013, Cynthia F. Ansari resigned as our Chief Executive Officer and President and Keith J.C. Darragh resigned as our Vice President, Finance and Principal Financial Officer and Principal Accounting Officer. While we have appointed Howard I. Zauberman as our Interim Chief Executive Officer and have commenced a search for a Chief Executive Officer and a Vice President, Finance, we can provide no assurance that we will be successful in our efforts to attract talented individuals to these important roles. Our failure to successfully recruit for these key positions could have a material adverse effect on our business and prospects.
Our medical products and manufacturing practices are subject to regulation by the FDA and by other state and foreign regulatory agencies
Our medical products are subject to extensive regulation in the U.S. and in the foreign countries where we do business. There can be no assurance that the required regulatory clearances will be obtained, and those obtained may include significant limitations on the uses of the product in question. In addition, changes in existing regulations or the adoption of new regulations could make our regulatory compliance more difficult in the future. The failure to obtain required regulatory clearances or to comply with applicable regulations may result in fines, delays, suspensions of clearances, seizures, recalls of products, operating restrictions or criminal prosecutions, and could have a material adverse effect on our operations.
Reimbursement from third-party healthcare payors is uncertain because of factors beyond our control, and changes in third-party healthcare payors’ policies could adversely affect our sales growth
In the U.S. and other foreign countries, government-funded or private insurance programs, or third-party payors, pay a significant portion of the cost of a patient’s medical expenses. There is no uniform policy of reimbursement among all these payers. We believe that reimbursement is an important factor to the success of our product sales.
All U.S. and foreign third-party reimbursement programs, whether government funded or commercially insured, are developing increasingly sophisticated methods of controlling healthcare costs through prospective reimbursement and capitation programs, group purchasing, redesign of benefits, careful review of bills, and exploring more cost-effective methods of delivering healthcare. These types of programs can potentially limit the amount which healthcare providers may be willing to pay for our products.
There can be no assurance that third-party reimbursement will continue to be available for procedures performed with our products. In addition, reimbursement standards and rates may change. We believe that the failure of users of our products to obtain adequate reimbursement from third-party payors has had a materially adverse effect on our sales, as there is no separate reimbursement code for our EndoSheath disposable.
Competition in our industry is intense, and many of our competitors have greater resources than we do
The flexible endoscopes and related products we currently sell and develop face competition primarily from medical products companies such as Olympus, Pentax, and Karl Storz. The principal competitors for our industrial products are Olympus, General Electric-Inspection Technologies, and Karl Storz Industrial. In addition, any company that is able to significantly redesign conventional flexible endoscopes to simplify the cleaning process, or significantly improve the current methods of cleaning flexible endoscopes, would provide competition for our products.
Many of our competitors and potential competitors have far greater financial resources, experience, research and development personnel, and manufacturing and marketing capabilities than we have. Our competitors could utilize their greater financial resources to acquire other companies to gain enhanced name recognition and market share, as well as to develop or acquire new technologies or products that could effectively compete with our product lines. In addition, it is possible that other large healthcare companies may enter the flexible endoscope market in the future.
Our ability to compete effectively depends upon our ability to distinguish our brand and our products from our competitors and their products and to obtain adequate reimbursement for procedures performed using our products. Factors affecting our competitive position include:
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ability to sell products tailored to meet the applications needs of customers and patients;
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sales, marketing, and distribution capabilities;
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product performance and design;
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quality of customer support;
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product pricing;
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product safety;
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success and timing of new product development and introductions; and
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intellectual property protection.
New product development in the medical device and supply industry is costly and labor intensive and has a very low rate of successful commercialization
Our success will depend in part on our ability to enhance our existing products and technologies and to develop and acquire new products. The development process for medical technology is complex, uncertain, time consuming, and costly. Product development requires the accurate assessment of technological and market trends as well as precise technological execution. We cannot assure you that (i) our product or technology development will be successfully completed; (ii) necessary regulatory clearances or approvals will be granted by the FDA or other regulatory bodies as required on a timely basis, or at all; or (iii) any product or technology we develop can be commercialized or will achieve market acceptance.
We may also be unable to locate suitable products or technologies to acquire or acquire such products or technologies on commercially reasonable terms. Failure to develop or acquire, obtain necessary regulatory clearances or approvals for, or successfully commercialize or market potential new products or technologies could have a material adverse effect on our financial condition and results of operations.
If we do not continue to develop and commercialize new products and identify new markets for our products and technologies we may not remain competitive, and our revenues and operating results could suffer
Our industry is subject to continuous technological development and product innovation. If we do not continue to innovate in developing new products and applications, our competitive position will likely deteriorate as other companies successfully design and commercialize new products and applications. Accordingly, our success depends in part on developing new and innovative applications of our technology and identifying new markets for and applications of existing products and technology. While we have reduced our research and development expenditures in an effort to focus our resources on marketing and selling our existing lines of products, if we are unable to continue to develop and commercialize new products and identify new markets for our products and technology, our products and technology could become obsolete and our revenues and operating results could be adversely affected.
We have spent a significant amount of time and resources on research and development projects, in an effort to develop and validate new and innovative products. While we believe that these projects will result in the manufacturing of new products and will create additional future sales, many factors including development delays, regulatory delays, safety concerns or patent disputes could prevent or delay the introduction or marketing of new products. Unanticipated issues may arise in connection with current and future clinical studies which could delay or terminate a product’s development prior to regulatory approval. We may also experience an unfavorable impact on our operating results if we are unable to capitalize on those efforts by attaining on a timely basis the proper FDA approval or other foreign regulatory approvals or to successfully market new products, including the new family of videoscope products or other flexible endoscope products.
Product quality problems could lead to reduced revenue, gross margins and net income
We produce highly complex videoscope products that incorporate sophisticated technology, including hardware and software. Software typically contains bugs that can unexpectedly interfere with operations. Our quality assurance testing programs may not be adequate to detect all defects, either ones in individual products or ones that could affect numerous shipments, which might interfere with customer satisfaction, reduce sales opportunities, or reduce gross margins. In the past, we have had to replace certain components and provide remediation in response to the discovery of defects or bugs in products that we had shipped. There can be no assurance that such a remediation, depending on the product involved, would not have a material impact. An inability to cure a product defect could result in the failure of a product line, a product recall, temporary or permanent withdrawal from a product or market, damage to our reputation, inventory costs or product reengineering expenses, any of which could have a material impact on our revenue, margins, and net income.
Product liability suits against us may result in expensive and time consuming litigation, payment of substantial damages, an increase in our insurance rates, and damage to our reputation, regardless of their merit
The development, manufacture, and sale of our products involve a significant risk of product liability claims. We maintain product liability insurance and believe that our level of coverage is adequate, given our business, products, past sales levels, our anticipated sales levels for fiscal 2014 and our claims experience. We evaluate annually the adequacy of the coverage of all our insurance policies and adjust our coverage accordingly. There can be no assurance that product liability insurance will continue to be available to us on acceptable terms, or that product liability claims in excess of our insurance coverage, if any, will not be successfully asserted against us in the future.
We face risks from selling our products in numerous international markets
Our operating results may suffer if we are unable to manage our international sales and marketing activities effectively. We sell some of our products in foreign countries, and we therefore are subject to risks associated with having international sales, such as:
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foreign certification and regulatory requirements;
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maintenance of agreements with competent distributors;
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import and export controls;
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currency exchange fluctuation; and
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political and economic instability.
Net sales to customers outside of the U.S. were approximately $5.0 million and $5.3 million for fiscal years 2013 and 2012, respectively, representing 33% and 32% of total net sales, respectively.
Our operating results could be negatively impacted by economic, political or other developments in countries in which we do business
Our business requires us to move products and components across international borders. Any events that interfere with, or increase the costs of, the transfer of goods across international borders could have a material adverse effect on our business.
We transport some of our goods across international borders, primarily those of the U.S., Canada, Europe, Japan, and Israel. Since September 11, 2001, there has been more intense scrutiny of goods that are transported across international borders. As a result, we may face delays, and increase in costs due to such delays in delivering goods to our customers. Any events that interfere with, or increase the costs of the transfer of goods across international borders could have a material adverse effect on our business.
Conditions in Israel affect our operations and may limit our ability to produce and sell our products
Currently, we use subcontractors in Israel to develop and produce some of our components and parts, the most material of which is Applitec Ltd., for parts of our videoscopes and video processors. Therefore, political, economic and military conditions in Israel have a direct influence on us. Our operations could be adversely affected by current hostilities involving Israel and the Hamas, a U.S. State Department-designated foreign terrorist organization. The interruption or curtailment of trade between Israel and its trading partners, or a significant downturn in the economic or financial condition of Israel, may adversely affect the flow of vital components from our Israeli subcontractors to us. Any hostilities related to Israel could have a material adverse effect on our business and on our share price.
In addition, because some of the components of our manufacturing and research and development subcontractors are located in Israel, we could experience disruption of our manufacturing, and research and development activities due to terrorist attacks or other hostilities. If our business activities would be disrupted, our revenues would be severely impacted. Our business interruption insurance may not adequately compensate us for losses that may occur, and any losses or damages we sustained could have a material adverse effect on our business.
Currency exchange rate fluctuations could adversely affect our operating results
Because some of our business includes international business transactions, costs and prices of our products or components in overseas countries are affected by foreign exchange rate changes. As a result, foreign exchange rate fluctuations may adversely affect our business, operating results and financial condition.
Currently, we do not enter into foreign exchange forward contracts and we do not hedge anticipated foreign currency cash flows.
We are exposed to credit risk of some of our customers
Most of our sales are on an open credit basis, with typical payment terms of 30 days in the U.S. (except for the 45 day terms with Stryker) and, because of local customs or conditions, longer in some markets outside the U.S. We monitor individual customer payment capability in granting such open credit arrangements, seek to limit such open credit to amounts we believe the customers can pay, and maintain reserves we believe are adequate to cover exposure for doubtful accounts. Beyond our open credit arrangements, we have also experienced demands for customer financing and facilitation of leasing arrangements, which we refer to leasing companies unrelated to us.
Our exposure to the credit risks may increase due to the current economic slowdown. Although we have programs in place that are designed to monitor and mitigate the associated risk, there can be no assurance that such programs will be effective in reducing our credit risks. Future credit losses, if incurred, could harm our business and have a material adverse effect on our operating results and financial condition. We maintain estimated accruals and allowances for our business terms. However, distributors tend to have more limited financial resources than other resellers and end-user customers and therefore represent potential sources of increased credit risk because they may be more likely to lack the reserve resources to meet payment obligations.
We may not be able to protect our intellectual property rights or technology effectively
Our success depends in part on our ability to maintain patent protection for our products, to preserve our trade secrets and to operate without infringing the proprietary rights of third parties. There can be no assurance that our pending patent applications will result in patents being issued, or that our competitors will not circumvent, or challenge the validity of, any patents issued to us. There can be no assurance that measures we have taken to protect our proprietary information will prevent the unauthorized disclosure or use of this information or that others will not be able to independently develop such information. In addition, if another party infringes our patent rights or other proprietary rights, the enforcement of such rights is at our option and can be a lengthy and costly process, with no guarantee of success. Moreover, there can be no assurance that claims alleging our infringement of another’s proprietary rights will not be brought against us in the future or that any such claims will not be successful. If we are unable to maintain the proprietary nature of our technologies, our ability to market or be competitive with respect to some or all of our products may be affected, which could reduce our sales and affect our ability to become profitable.
There can be no assurance that our pending patent applications will result in patents being issued or that our competitors will not circumvent, or challenge the validity of, any patents issued to us.
Some of the technology used in, and that may be important to, our products is not covered by any patent or patent application. We seek to maintain the confidentiality of our proprietary technology by requiring our employees to sign confidentiality agreements, and by limiting access by outside parties to such confidential information. However, there can be no assurance that these measures will prevent the unauthorized disclosure or use of this information, or that others will not be able to independently develop such information. Moreover, as is the case with our patent rights, the enforcement of our trade secret rights can be lengthy and costly, with no guarantee of success.
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 benefits or harm our existing business
Our success will depend, in part, on our ability to expand our product offerings and grow our business in response to changing technologies, customer demands and competitive pressures. In some circumstances, we may seek to do so through the acquisition of complementary businesses, products or technologies rather than through internal development. The identification of suitable acquisition candidates and obtaining adequate financing can be difficult, time consuming and costly, and we may not be able to successfully complete identified acquisitions. Furthermore, even if we successfully complete an acquisition, we may not be able to successfully integrate newly acquired organizations, products or technologies into our operations, and the process of integration could be expensive, time consuming and may strain our resources. Consequently, we may not achieve anticipated benefits of the acquisitions, which could harm our existing business. In addition, future acquisitions could result in potentially dilutive issuances of equity securities or the incurrence of debt, contingent liabilities or expenses, or other charges such as in-process research and development, any of which could harm our business and affect our financial results or cause a reduction in the price of our common stock.
Our industrial segment’s financial performance is substantially dependent on the conditions of the commercial aviation industry
The results of our industrial segment, which generated approximately 24% of our net sales in fiscal 2013, are influenced by a number of external factors including general economic conditions in the U.S. and internationally, and are directly tied to the economic conditions in the commercial aviation and defense industries, which are cyclical in nature, and airlines’ financial performance can also be influenced by production and utilization of transport equipment.
The challenging operating environment currently faced by commercial airlines is expected to continue. As a result, capital spending by commercial airlines and aircraft manufacturers may be influenced by a wide variety of factors, including current and predicted traffic levels, load factors, aircraft fuel pricing, labor issues, worldwide airline profits, airline consolidation, airline insolvencies, competition, the retirement of older aircraft, regulatory changes, terrorism and related safety concerns, general economic conditions, corporate profitability, and backlog levels, all of which could reduce the demand for air travel and the aftermarket sales and margins of our industrial segment. Future terrorist actions or pandemic health issues could dramatically reduce both the demand for air travel and aftermarket sales and margins of our industrial segment. A reduction in capital spending in the commercial aviation or defense industries could have a significant effect on the demand for our products, which could have an adverse effect on our financial performance or results of operations.
Our officers and directors have the ability to exercise significant control over the Company
Our officers and directors own an aggregate of approximately 38% of our outstanding common stock. As a result, our officers and directors exercise significant control over all matters requiring stockholder approval, including the election of directors and approval of significant corporate transactions. This concentration of ownership may have the effect of delaying or preventing a change in control of the Company or forcing management to change its operating strategies, which may be to the benefit of management but not in the interest of the stockholders.
Our common stock is thinly traded, so you may be unable to sell at or near “ask” prices or at all if you need to sell your shares to raise money or otherwise desire to liquidate your shares.
Our common stock is thinly traded, meaning there has been a low volume of buyers and sellers of the shares. Although we continue to undertake efforts to develop our market recognition and support for our shares of common stock in the public market, the price and volume for our common stock cannot be assured. The number of persons interested in purchasing our common stock at or near “ask” prices at any given time may be relatively small or non-existent. This situation may be attributable to a number of factors, including the fact that we are a small company that is relatively unknown to stock analysts, stockbrokers, institutional investors and others in the investment community that generate or influence sales volume. Even if we capture the attention of these persons, they may be risk-averse and would be reluctant to follow a company such as ours or purchase or recommend the purchase of our shares until such time as our share price and volume becomes more viable. As a consequence, there may be periods of several days, weeks or months when trading activity in our shares is minimal or non-existent, as compared to a seasoned issuer with a large and steady volume of trading activity that will generally support continuous sales without an adverse effect on share price. We cannot give you any assurance that a broader or more active public trading market for our common stock will develop or be sustained, or that current trading levels will be sustained or not diminish.
Item 1B.
Item 1B. Unresolved Staff Comments
None.
Item 2.
Item 2. Properties
We occupy 20,500 square feet in our facility in Orangeburg under a lease that expires in August 2015. Our Natick facility occupies 9,835 square feet under a lease that expires in June 2014.
Our existing Natick and Orangeburg facilities are registered with the FDA as medical device manufacturing facilities and, therefore, are subject to the FDA’s Quality System Regulation regarding manufacturing, testing, quality control, and documentation procedures. We believe that the physical characteristics and layouts of these facilities are adequate to manufacture our products in compliance with applicable FDA regulations. In addition, both facilities are registered as meeting the requirements of ISO 13485: 2003 and the Medical Device Directive, allowing us to sell our medical products in Europe and Canada.
Item 3.
Item 3. Legal Proceedings
As of March 31, 2013, we had no material legal proceedings to which we, or any of our subsidiaries, are a party or to which any of our properties are subject.
Item 4.
Item 4. Mine Safety Disclosures
Not applicable.
PART II
Item 5.
Item 5. Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Our common stock is listed on the NASDAQ Capital Market under the symbol “VSCI.” The following table sets forth, for the periods indicated, the high and low sale prices of our common stock:
As of June 21, 2013, we had 46,249,242 outstanding shares of common stock held by approximately 161 stockholders of record, without giving effect to determining the number of stockholders who held shares in “street name” or other nominee accounts.
Dividend Policy
We have never paid cash dividends on our common stock, and we do not expect to pay any cash dividends on our common stock in the foreseeable future.
Securities Authorized for Issuance Under Equity Compensation Plans
The following table provides information about the securities authorized for issuance under our equity compensation plans as of March 31, 2013:
i.
Does not include awards covering 1,880,620 stock warrants that are outstanding as of March 31, 2013. Shares issuable under the 2007 Stock Incentive Plan may also be issued in the form of restricted shares, stock appreciation rights, performance shares, or other equity-based awards.
ii.
Includes any shares of common stock or stock option that would be issuable pursuant to the 2003 Director Option Plan and restricted shares, stock appreciation rights, performance shares, or other equity-based awards that are issuable under the 2007 Stock Incentive plan.
Sales of Unregistered Securities
On September 30, 2011, in connection with the amended revolving loan agreement entered into with Lewis C. Pell, our Chairman, Mr. Pell received a warrant to purchase an aggregate of 1,229,105 shares of our common stock at an exercise price of $2.034 per share (the “New Warrant”). The New Warrant vested immediately upon issuance and expires on the later of the fifth anniversary of the New Warrant or one year after the termination of the Loan Agreement and repayment of all amounts due and payable thereunder. As part of the Original Agreement, Mr. Pell received warrants to purchase up to 272,727 shares of our common stock at an exercise price of $1.375 per share and up to 378,788 shares of our common stock at an exercise price of $1.65 per share. Such warrants were issued to Mr. Pell in a transaction exempt from registration under the Securities Act of 1933, as amended pursuant to Section 4(2) under the Securities Act.
Other than as provided above, within the past two fiscal years we did not sell any securities that were not registered under the Securities Act.
Issuer Purchases of Equity Securities
We did not repurchase any shares of our common stock during the three months ended March 31, 2013. We have historically purchased shares from management employees to cover income tax withholdings as result of the lapsing of restrictions on restricted stock awards. Although not required to under our equity incentive plans, we anticipate repurchasing shares in a similar arrangement during fiscal 2014.
Item 6.
Item 6. Selected Financial Data
We are a smaller reporting company, as defined in Rule 12b-2 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and are not required to provide the information required by this item.
Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Executive Overview
We design, develop, manufacture, and market products for endoscopy - the science of using an instrument, known as an endoscope - to provide minimally invasive access to areas not readily visible to the human eye. We have two reportable segments, medical and industrial. Each of these operating segments has unique characteristics and faces different opportunities and challenges.
Medical Business Segment
Our medical segment designs, manufactures, and sells our advanced line of endoscopy-based products, including our flexible fiber and video endoscopes and our EndoSheath technology, for a variety of specialties and markets. Our proprietary reusable flexible endoscope is combined with a single-use, sterile protective EndoSheath disposable that is placed over the patient contact area of the scope. Our “always sterile” EndoSheath technology reduces the risks of cross-contamination associated with the reuse (or “reprocessing”) of conventional endoscopes, which are difficult, costly, and time-consuming to clean and disinfect or sterilize.
In November 2012, the ECRI Institute listed cross-contamination from flexible endoscopes as the fourth most dangerous hazard on its list of the top-ten health technology hazards for 2012. The use of our EndoSheath technology allows healthcare providers to perform a rapid, simplified reprocessing routine after use, avoiding the elaborate high level disinfection/sterilization routines required by the U.S. Food and Drug Administration (the “FDA”) for conventional endoscopes. The FDA requires that all conventional flexible endoscopes be reprocessed according to FDA-cleared manufacturers’ regulations and organizational guidelines, whether they are used in hospitals, clinics or office settings. With our EndoSheath technology we are able to reduce the steps needed to reprocess flexible endoscopes from approximately 27 to three, thereby lowering costs and saving time. This design of “always ready” equipment, which allows for a rapid and less damaging cleaning process, provides a multitude of benefits to healthcare practitioners, such as lower capital equipment investment, less service and maintenance costs of capital equipment, less staff exposure to toxic chemicals, increased patient scheduling flexibility and throughput, improved staff productivity and a more practical implementation of endoscopy.
We target six market spaces for our endoscopes and our EndoSheath technology:
●
Urology - we supply our cystoscopes, ureteroscopes, and EndoSheath technology to the Endoscopy Division of Stryker Corporation (“Stryker”) in North and Latin America, South America, China and Japan. Although Stryker was to receive the exclusive rights for the rest of the world in April 2012, we reached an agreement with Stryker to delay this launch indefinitely. Until we agree with Stryker on the date of such launch, we will continue to manufacture and sell our cystoscopes and EndoSheath technology to our independent distributors for sale in the rest of the world.
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Critical Care / Pulmonology - we manufacture, market, and sell our bronchoscope (an endoscope that allows detailed viewing of the lungs) and EndoSheath technology to intensivists, pulmonologists, thoracic surgeons, and other airway-related physicians.
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Surgery - we manufacture, market, and sell our TNE (trans-nasal esophagoscopy) endoscope and EndoSheath technology to general surgeons, primarily bariatric and gastroesophageal reflux disease (“GERD”) surgeons.
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Gastroenterology - we manufacture, market, and sell our TNE endoscopes and EndoSheath technology to gastroenterology (“GI”) physicians, ear, nose, and throat (“ENT”) physicians and others with a GI focus as part of their practice.
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ENT (ear, nose, and throat) - we manufacture, market, and sell our ENT endoscopes to ENT physicians.
●
Spine - we supply our flexible video surgical endoscope systems to SpineView, Inc. for use with SpineView’s space creator product.
We believe our technology delivers significant value to our customers - doctors, clinics, and hospitals - through reduced capital, lower staff and service costs, and increased patient throughput, practice revenue, and profitability. Our goal is to become a customer-centric organization with a focus on enhancing stockholder value. We are doing this by:
●
Increasing the size and capabilities of our sales force in the U.S. by adding proven medical-surgical device sales professionals in promising territories;
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Targeting acute care facilities and office-based clinics that recognize patient safety and the patient experience as a primary value position;
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Capitalizing on our extensive and relevant library of published clinical studies on the efficacy and safety of our EndoSheath technology; and
●
Enhancing our professional educational programs to enable healthcare professionals to teach other healthcare professionals about our EndoSheath technology.
Recent Medical Business Product Launches
In December 2012, we began to exclusively supply to Stryker our first charge-coupled device (CCD) based flexible ureteroscope. This ureteroscope expands our new 7000 Series video endoscopy platform and is the smallest CCD-based video endoscope in the marketplace today. Ureteroscopes are used for diagnostic and therapeutic procedures in the ureter and the kidney, typically performed in a hospital operating room setting.
We also launched our next-generation digital video processor, the DPU-7000. This integrated visualization endoscopy platform is a high-performance, efficient, and easy-to-use system designed to provide expanded benefits across a broader spectrum of users. The DPU-7000 is the first all-in-one endoscopy platform to include audio, video, archiving, and workflow enhancements in a single standalone unit. It is fully compatible with our 5000 Series line of endoscopes that utilize our EndoSheath technology.
Industrial Business Segment
Our industrial segment, through our wholly-owned subsidiary Machida, designs, manufactures, and sells borescopes to a variety of users, primarily in the aircraft engine manufacturing and aircraft engine maintenance industries. A borescope is an instrument that uses optical fibers for the visual inspection of narrow cavities. Our borescopes are used to inspect aircraft engines, casting parts and ground turbines, among other items.
Machida’s quality line of borescopes includes a number of advanced standard features normally found only in custom designed instruments. We were the first to offer a flexible borescope with a grinding attachment, allowing users to “blend” or smooth small cracks in turbine blades of jet engines without disassembling the engine, saving our customers significant expense and delay.
Financing Arrangements
Long-Term Debt - Related Party
On September 19, 2012 (the “Effective Date”), we entered into a new $20.0 million convertible promissory note (the “Replacement Note”) with our chairman, Lewis C. Pell (the “Lender”). The Replacement Note consolidates and restructures the $15.0 million in aggregate borrowings collectively outstanding under the Original Agreement (as defined below) and the Supplemental Note (as defined below) and provides for an additional $5.0 million available to us (of which $2.0 million has been drawn as of March 31, 2013), for an aggregate of up to $20.0 million. We also terminated the letter agreement dated August 14, 2012, pursuant to which Mr. Pell had agreed to provide financial assistance to us in the amount of up to $3.0 million.
The Replacement Note accrues annual interest, payable annually, and is set at the “applicable federal rate” in effect on the date of the Replacement Note (as defined in the Replacement Note; equal to 0.84%). The Replacement Note must be repaid in full on or before its fifth anniversary (the “Maturity Date”), but may be prepaid by us at any time without penalty. We will be required to repay all amounts outstanding under the Replacement Note upon an event of default, as defined in the Replacement Note.
The outstanding principal amount of the Replacement Note is convertible at any time prior to the Maturity Date, at Mr. Pell’s option, into shares of our common stock at a conversion price of $1.20 per share, which was the closing price of our common stock on the Effective Date.
The Replacement Note replaces the original loan agreement between us and Mr. Pell dated September 30, 2011 (the “Original Agreement”) pursuant to which we borrowed $10.0 million, and the promissory note dated July 25, 2012 (the “Supplemental Note”) pursuant to which we borrowed $5.0 million. The amounts borrowed against the Original Agreement and Supplemental Note accrued interest at an annual rate of 7.5%. Mr. Pell also had received an availability fee equal to an annual rate of 0.5% on the difference between the average annual principal amount of the outstanding balance under the Original Agreement and the maximum amount of $10.0 million.
At March 31, 2013, we had $17.0 million in outstanding borrowings and $3.0 million available under the Replacement Note. The outstanding balance is reflected as convertible debt - related party on our consolidated balance sheet. See Subsequent Event section below.
Equity Purchase Agreement
On April 27, 2012, we entered into a purchase agreement (the “Purchase Agreement”) with Lincoln Park Capital Fund, LLC (“LPC”), pursuant to which we have the right to sell to LPC up to $15 million in shares of our common stock from time-to-time over a period of up to three years, subject to certain limitations and conditions set forth in the Purchase Agreement. This total maximum amount of $15 million would increase to $21 million if the aggregate market value of shares of our common stock held by non-affiliates reached at least $75 million during the 36-month term of the Purchase Agreement. The Purchase Agreement contains customary representations, warranties and agreements between us and LPC, limitations (market price of our common stock and LPC’s ownership limit) and conditions to completing future sale transactions, indemnification rights and other obligations of the parties. In connection with the initial purchase under the Purchase Agreement, and any future sales under the Purchase Agreement, Mr. Pell waived the repayment requirement under the Loan Agreement. On July 26, 2012, we amended the Purchase Agreement with LPC to, among other things, create a threshold price of $3.00 for the sale of our common stock to LPC, as calculated pursuant to the formula provided in the Purchase Agreement.
As consideration for entering into the Purchase Agreement and for their initial purchase of $1.0 million of our common stock, we issued to LPC 175,333 shares of our common stock. As consideration for any remaining future purchases under the Purchase Agreement, we also will also issue to LPC, on a pro rata basis in connection with each purchase of shares by LPC, up to a total of 215,000 additional shares of our common stock. We did not receive any cash proceeds from the issuance of 175,333 shares and will not receive any proceeds upon the issuance of any of the remaining 215,000 shares.
Subsequent Event
Pursuant to a letter agreement dated June 21, 2013, Mr. Pell has agreed to provide financial assistance to us in the amount of up to $5.0 million, if necessary to support our operations, for a period ending on the earlier of (i) July 1, 2014 or (ii) our raising debt or equity capital in the amount of $5.0 million or more. This financial assistance, if drawn by us, would be on the same terms as our existing convertible debt with Mr. Pell. We expect that our cash at March 31, 2013, together with the $3 million of capital available under a convertible note dated September 19, 2012 and $5.0 million of capital to be made available to us, subject to certain conditions, under a letter agreement dated June 21, 2013 from Lewis C. Pell, our Chairman (see Note 13. Subsequent Event for additional information), should be sufficient to fund our operations through at least March 31, 2014. However, if our performance expectations fall short (including our failure to generate expected levels of sales) or our expenses exceed expectations, we will need to reduce our expenses and/or secure additional funding to support our operational needs in the future, and we cannot be certain that such funding will be available on terms acceptable to us, if at all, particularly in light of current economic and capital market conditions for companies of our size. Any capital raising necessary to continue our operations may be through one or a combination of approaches, which could include public or private financing, issuances of equity or debt, sale or partnering of one or more of our assets or other strategic initiatives. Any public or private financings involving issuances of common stock or other classes of our equity would likely dilute existing stockholders’ percentage ownership. If we are unable to obtain funding to support operations, we will be forced to curtail our operations and we may be less likely to develop and market products successfully, which would have a material adverse impact on our prospects and financial condition. If required, we believe we would be able to reduce our expenses to a sufficient level to continue to operate as a going concern.
Critical Accounting Policies and Estimates
The preparation of our consolidated financial statements requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Management evaluates these estimates and assumptions on an ongoing basis. Estimates are based on historical experience, when available, and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
Management believes that, of its significant accounting policies, an understanding of the following critical accounting policies is important in obtaining an overall understanding of the consolidated financial statements.
Revenue Recognition
We recognize revenue in accordance with the Financial Accounting Standards Board (the “FASB”) Accounting Standards Codification (“ASC”) 605 (Topic 605, Revenue Recognition). ASC 605 requires that five basic criteria must be met before revenue can be recognized: (i) persuasive evidence that an arrangement exists; (ii) delivery has occurred or services were rendered; (iii) the fee is fixed and determinable; (iv) collectability is reasonably assured; and (v) the fair value of undelivered elements, if any, exists. Determination of criterion (iv) above is based on management’s judgment regarding the collectability of invoices for products and services delivered to customers. Should changes in conditions cause management to determine this criterion is not met for certain future transactions, revenue recognized for any reporting period could be adversely affected. We recognize revenue when title passes to the customer, generally upon shipment of our products F.O.B. shipping point. Revenue for service repairs of equipment is recognized after service has been completed, and service contract revenue is recognized ratably over the term of the contract.
For products sold to Stryker we recognize revenue in a two-step process. The first step is recognition of revenue for our cost to manufacture these products when title passes to Stryker, generally upon shipment of our products F.O.B. shipping point. The second step is recognition of revenue for our specified margin of Stryker’s gross profit after Stryker sells the products to its end customers, based upon reports received from Stryker monthly. There is no minimum amount of scopes and EndoSheath products that Stryker is required to purchase from us.
Stock-Based Compensation
We account for stock-based awards issued to employees in accordance with the provisions of ASC 718 (Topic 718, Compensation - Stock Compensation). We recognize stock-based compensation expense on a straight-line uniform basis over the service period of the award, which is generally four years for employees. We use historical data to estimate expected employee behaviors related to option exercises and forfeitures and include these expected forfeitures as a part of the estimate of stock-based compensation expense as of the grant date. For stock-based awards with performance-based vesting conditions, we are also required to estimate the probability of the vesting conditions being met. Stock-based awards issued to consultants are accounted for in accordance with the provisions of ASC 718 and ASC 505-50 (Subtopic 50 “Equity-Based Payments to Non-Employees” of Topic 505, Equity). Options granted to consultants are periodically revalued as the options vest, and are recognized as an expense over the related period of service or the vesting period, whichever is longer.
Warranty Obligations
We provide for the estimated cost of warranties at the time the related revenue is recognized based on the number of units sold, historical and anticipated rates of warranty claims, and cost per claim. We periodically assess the adequacy of our recorded warranty liabilities and adjust the amounts as necessary. Warranty expense is recorded in cost of sales in our consolidated statement of operations.
Income Taxes
We account for income taxes in accordance with ASC 740 (Topic 740, Income Taxes). ASC 740 prescribes that the use of the liability method be used for income taxes. Under this method, deferred tax assets and liabilities are determined based on differences between the financial reporting and tax basis of assets and liabilities and are measured using enacted tax rates and laws that are expected to be in effect when the differences reverse. Any resulting net deferred tax assets are evaluated for recoverability and, accordingly, a valuation allowance is provided when it is more likely than not that all or some portion of the deferred tax asset will not be realized.
ASC Topic 740 also clarifies the accounting for uncertainty in income taxes recognized in the financial statements. This interpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken, or expected to be taken, in a tax return.
Additionally, ASC Topic 740 provides guidance on the recognition of interest and penalties related to income taxes. We have elected to treat interest and penalties, to the extent they arise, as a component of selling, general, and administrative expenses in our consolidated statement of operations.
Results of Operations (Dollars in thousands, except per share amounts)
Net Sales
In the medical segment, we track sales of our endoscopes and EndoSheath technology by market. We also track sales of peripherals and accessories that can be sold to more than one market. Net sales by operating segment and by market/category for fiscal years 2013 and 2012 were as follows:
Net sales decreased $1.4 million, or 8%, in fiscal 2013 to $15.3 million compared to $16.7 million in fiscal 2012. During fiscal 2013, our medical segment’s net sales of $11.6 million decreased by $2.1 million, or 15%, primarily attributable to lower sales of our endoscopes and EndoSheath disposables to Stryker in the urology market ($1.2 million). Our industrial segment’s net sales of $3.7 million increased by $0.7 million, or 24%, primarily attributable to higher demand for our 2.0 mm video-based borescopes, engine turning tools, and custom blending scopes. Although we achieved growth in fiscal 2013 in our industrial segment, we expect future industrial sales to remain relatively flat given the maturity of our products.
The following table summarizes net sales by market/category and by product for our medical operating segment for fiscal years 2013 and 2012:
Net sales to the urology market in fiscal 2013 decreased by $1.7 million, or 24%, as compared to fiscal 2012. The year-over-year decline was primarily attributable to the lower sales of our cystoscopes and related EndoSheath technology products to Stryker stemming from initial stocking of product in fiscal 2012 to support their April 2011 launch efforts. Net sales to Stryker were down $1.2 million, or 29%, in fiscal 2013.
Net sales to the ENT market in fiscal 2013 decreased by $26 thousand, or 1%, as compared to fiscal 2012. The nominal decrease was primarily attributable to lower sales of our ENT fiberscopes in the U.S. as our domestic sales force concentrated their selling efforts in the surgical and critical care markets ($229 thousand). Partially offsetting this decline was growth of our ENT fiberscopes in the international markets ($195 thousand), primarily Israel.
Net sales to the surgery and GI markets in fiscal 2013 increased by $67 thousand, or 7%, as compared to fiscal 2012. An increase in demand for our EndoSheath technology contributed to the year-over-year growth ($55 thousand). Our effort to drive awareness of the efficacy and safety of our EndoSheath technology and increase utilization resulted in the 49% unit volume increase in fiscal 2013.
Net sales to the pulmonology and critical care markets in fiscal 2013 decreased by $0.1 million, or 12%, as compared to fiscal 2012. The year-over-year decline was primarily attributable to lower sales of our video platform (video-based bronchoscope and digital processing unit) in the U.S. ($0.2 million), partially offset by higher demand for our video-based bronchoscopes in the international markets, primarily Italy and Switzerland ($0.1 million). Our focus remains on increasing our installed base in the U.S. to drive further adoption of our EndoSheath technology.
Net sales to SpineView in fiscal 2013 decreased by $0.4 million, or 47%, as compared to fiscal 2012. We fulfilled the remaining balance of the initial stocking order of fifty (50) 2.0mm video-based surgical endoscope systems in the second quarter of fiscal 2013. In December 2012, SpineView received 510(k) clearance from the Food and Drug Administration (“FDA”) to use our system for spine applications. With this clearance and the units supplied from the initial stocking order, SpineView has been conducting clinical preference trials for minimally invasive spine surgeries.
Net sales of all repairs, peripherals, and accessories in fiscal 2013 increased by $85 thousand, or 4%, as compared to fiscal 2012. The year-over-year growth was primarily attributable to an increase in our repairs business, which increased 12% in fiscal 2013.
Gross Profit (Net Sales Less Cost of Sales)
Gross profit by operating segment for fiscal years 2013 and 2012 was as follows:
The gross margin percentage was 28% in fiscal 2013 compared to 30% in fiscal 2012. The year-over-year decline was primarily attributable to a reduction in the allocation of manufacturing expenses to support research and development activities (gross margin percentage point impact of 3% in fiscal 2013). We successfully completed and launched several new products in fiscal 2013, including our next generation digital processing unit, the DPU-7000, and the flexible ureteroscope for Stryker.
Operating Expenses (Selling, General, and Administrative (“SG&A”) and Research and Development (“R&D”)
Operating expenses by operating segment for fiscal years 2013 and 2012 were as follows:
SG&A Expenses
SG&A expenses were $11.0 million in fiscal 2013 representing a decrease of $1.0 million, or 9%, as compared to fiscal 2012. The decrease was primarily attributable to lower stock-based compensation expense ($0.5 million), lower vacation pay expense ($0.3 million), and a reduction in trade show and convention costs as we targeted those events that are most relevant to our business in fiscal 2013.
R&D Expenses
R&D expenses were $1.8 million in fiscal 2013 representing a decrease of $1.3 million, or 42%, as compared to fiscal 2012. The year-over-year decline was primarily attributable to lower product development costs associated with the products noted in the gross profit discussion above as we shifted from the development stage to the product launch phase ($0.7 million) and a reduction in manufacturing efforts to support such development activities ($0.5 million).
Other (Expense) Income
Other (expense) income for fiscal years 2013 and 2012 was as follows:
* not meaningful
Other expense was $2.1 million in fiscal 2013 representing an increase of $1.2 million, or 130%, as compared to fiscal 2012. In connection with the termination of the previous debt arrangements with our Chairman, we wrote-off the remaining deferred debt cost balance of $1.2 million at September 19, 2012 and classified the transaction as a loss on the extinguishment of debt.
Liquidity and Capital Resources
The following table summarizes selected financial information and statistics as of March 31, 2013 and 2012:
We consider our cash and cash equivalents, together with capital available to us under from Lewis C. Pell (as described in “Outlook” below), to be our principal sources of liquidity. Cash and cash equivalents at March 31, 2013 were $0.8 million compared to $2.7 million at March 31, 2012. Working capital was $7.0 million at the end of fiscal 2013 compared to $6.0 million at the end of fiscal 2012. The increase in working capital was primarily attributable to higher accounts receivable and inventories. We utilized some of the cash raised from the issuance of convertible debt to build inventory to support our sales backlog of $1.7 million at March 31, 2013.
In fiscal 2013, we used $9.6 million of net cash in our operating activities compared to $11.6 million in fiscal 2012. The year-over-year decline was primarily attributable to the realization of cash receipts from customers that had advanced us money during fiscal 2011. In fiscal 2012, we were fulfilling orders to complete the advances from Stryker and SpineView and did not receive any cash payments for these sales.
In fiscal 2013, we used $0.1 million of net cash from our investing activities compared to $0.2 million in fiscal 2012. The decrease was primarily attributable to lower capital expenditures during fiscal 2013.
In fiscal 2013, we provided $7.9 million of net cash from our financing activities compared to $5.3 million in fiscal 2012. The increase was primarily attributable to the net proceeds from the issuance of convertible debt (related party) and the sale of common stock to LPC during fiscal 2013.
Outlook
We have incurred substantial operating losses since our inception and there can be no assurance that we will ever achieve or sustain a profitable level of operations in the future. We anticipate that we will continue to incur negative cash flows from operations during fiscal 2014, driven by continued investment in a direct sales force for the U.S. market, spending for marketing, and general business operations. As of March 31, 2013, we had cash and cash equivalents totaling approximately $0.8 million. We expect that our cash at March 31, 2013, together with the $3 million of capital available under a convertible note dated September 19, 2012 and $5.0 million of capital to be made available to us, subject to certain conditions, under a letter agreement dated June 21, 2013 from Lewis C. Pell, our Chairman (see Subsequent Event section below for additional information), should be sufficient to fund our operations through at least March 31, 2014. However, if our performance expectations fall short (including our failure to generate expected levels of sales) or our expenses exceed expectations, we will need to reduce our expenses and/or secure additional funding to support our operational needs in the future, and we cannot be certain that such funding will be available on terms acceptable to us, if at all, particularly in light of current economic and capital market conditions for companies of our size. Any capital raising necessary to continue our operations may be through one or a combination of approaches, which could include public or private financing, issuances of equity or debt, sale or partnering of one or more of our assets or other strategic initiatives. Any public or private financings involving issuances of common stock or other classes of our equity would likely dilute existing stockholders’ percentage ownership. If we are unable to obtain funding to support operations, we will be forced to curtail our operations and we may be less likely to develop and market products successfully, which would have a material adverse impact on our prospects and financial condition. If required, we believe we would be able to reduce our expenses to a sufficient level to continue to operate as a going concern.
Contractual Obligations
Set forth below is a summary of our current obligations as of March 31, 2013 to make future payments due by the period indicated below, excluding payables and accruals. We expect to be able to meet our obligations in the ordinary course.
Contractual commitments in the table above represent future cash obligations that are legally binding and enforceable under agreements with third parties. These amounts relate to future minimum payments under our convertible debt and operating and capital leases. The table summarizes our significant contractual commitments as of March 31, 2013 and the effects such commitments are expected to have on our liquidity and cash flows in future periods.
Off-Balance Sheet Arrangements
At March 31, 2013, we had no off-balance sheet arrangements.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
We are a smaller reporting company, as defined in Rule 12b-2 of the Exchange Act, and are not required to provide the information required by this item.
Item 8.
Item 8. Financial Statements and Supplementary Data
See Financial Statements following Item 15 of this Annual Report on Form 10-K.
Item 9.
Item 9. Changes In and Disagreements With Accountants on Accounting and Financial Disclosure
None.
Item 9A.
Item 9A. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
We have evaluated, under the supervision and with the participation of our senior management, including our Interim Chief Executive Officer (“Interim CEO”) and Principal Financial Officer (“PFO”), the effectiveness of the design and operation of our disclosure controls and procedures of the end of the period covered by this Annual Report on Form 10-K. Based on that evaluation, the Interim CEO and the PFO concluded that our disclosure controls and procedures as of the end of the period covered by this Annual Report on Form 10-K have been designed and are functioning effectively to provide reasonable assurance that the information required to be disclosed by us in reports filed under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. We believe that a control system, no matter how well designed and operated, cannot provide absolute assurance that the objectives of the control system are met, and no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within a company have been detected.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting identified in connection with the evaluation required by paragraph (d) of Exchange Act Rules 13a-15 or 15d-15 that occurred during the last fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Management’s Annual Report on Internal Control over Financial Reporting
Our management is responsible for the preparation, integrity and fair presentation of information in our consolidated financial statements, including estimates and judgments. The consolidated financial statements presented in this Annual Report on Form 10-K have been prepared in accordance with accounting principles generally accepted in the United States. Our management believes the consolidated financial statements and other financial information included in this Annual Report on Form 10-K fairly present, in all material respects, our consolidated financial condition, results of operations and cash flows as of and for the periods presented in this Annual Report on Form 10-K.
Our management is responsible for establishing and maintaining adequate internal control over financial reporting. Our internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of consolidated financial statements for external purposes in accordance with accounting principles generally accepted in the United States.
Our internal control over financial reporting includes those policies and procedures that:
●
pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect our transactions and dispositions of our assets;
●
provide reasonable assurance that our transactions are recorded as necessary to permit preparation of our consolidated financial statements in accordance with accounting principles generally accepted in the United States and that our receipts and expenditures are being made only in accordance with authorization of our management and our directors; and
●
provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on the consolidated financial statements.
Because of its inherent limitations, internal control over financial reporting can provide only reasonable assurance and may not prevent or detect misstatements. Also, projections of any evaluation of the effectiveness of such controls in future periods are subject to the risk that the controls may become inadequate because of changes in conditions or that the degree of compliance with the policies and procedures may deteriorate.
Our management conducted an assessment of the effectiveness of internal control over financial reporting based on the framework in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this assessment, our management concluded that, as of March 31, 2013, our internal control over financial reporting was effective to provide reasonable assurance regarding the reliability of financial reporting and the preparation of consolidated financial statements for external purposes in accordance with accounting principles generally accepted in the United States.
Attestation Report of the Registered Public Accounting Firm
As a smaller reporting company, this Annual Report on Form 10-K is not required to include an attestation report of our registered public accounting firm regarding internal control over financial reporting.
Item 9B.
Item 9B. Other Information
None.
PART III
Item 10.
Item 10. Directors, Executive Officers, and Corporate Governance
Directors
The information required by this Item 10 with respect to our Directors is incorporated herein by reference to the information contained under the caption “Proposal 1: Election of Class I Directors” in our definitive proxy statement related to the 2013 annual meeting of stockholders, to be filed within 120 days after the end of the year covered by this Annual Report on Form 10-K.
Executive Officers of the Company
The information concerning our executive officers required by this Item is provided under the caption “Executive Officers of the Company” in Part I, Item 1 of this Annual Report on Form 10-K.
Section 16(a) Beneficial Ownership Reporting Compliance
The information required by this Item 10 concerning Section 16(a) beneficial ownership reporting compliance by our directors and executive officers is incorporated herein by reference to the information contained under the caption “Section 16(a) Beneficial Ownership Reporting Compliance” in our definitive proxy statement related to the 2013 annual meeting of stockholders, to be filed within 120 days after the end of the year covered by this Annual Report on Form 10-K.
Code of Ethics
The information required by this Item 10 concerning our code of ethics is incorporated herein by reference to the information contained under the caption “Board Structure and Governance -Code of Ethics” in our definitive proxy statement related to the 2013 annual meeting of stockholders, to be filed within 120 days after the end of the year covered by this Annual Report on Form 10-K.
Item 11.
Item 11. Executive Compensation
The information required by this item is incorporated by reference from our definitive proxy statement related to the 2013 annual meeting of stockholders to be filed with the Securities and Exchange Commission within 120 days after the end of the fiscal year covered by this Annual Report on Form 10-K.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The information required by this item is incorporated by reference from our definitive proxy statement related to the 2013 annual meeting of stockholders to be filed with the Securities and Exchange Commission within 120 days after the end of the fiscal year covered by this Annual Report on Form 10-K.
Item 13.
Item 13. Certain Relationships and Related Transactions and Director Independence
The information required by this item is incorporated by reference from our definitive proxy statement related to the 2013 annual meeting of stockholders to be filed with the Securities and Exchange Commission within 120 days after the end of the fiscal year covered by this Annual Report on Form 10-K.
Item 14.
Item 14. Principal Accountants Fees and Services
The information required by this item is incorporated by reference from our definitive proxy statement related to the 2013 annual meeting of stockholders to be filed with the Securities and Exchange Commission within 120 days after the end of the fiscal year covered by this Annual Report on Form 10-K.
PART IV
Item 15.
Item 15. Exhibits and Financial Statement Schedules
(a) 2. Financial Statement Schedules
All schedules have been omitted because they are not required, not applicable, or the information is otherwise set forth in the consolidated financial statements or notes thereto.
(a)
3. Exhibits
Some of the agreements filed (or incorporated by reference) as exhibits to this Annual Report on Form 10-K contain representations and warranties and other statements by the parties to those agreements, which were made at the time of those agreements solely for the benefit of the parties to those agreements and should not be relied on as accurate statements of fact by readers of this Form 10-K or any other person. Those representations, warranties and other statements were made only as of dates specified in those agreements and do not reflect later developments or changes. Additionally, those representations, warranties and other statements may not properly reflect actual conditions at the time they were made because: (1) they may have been subject to differing standards of materiality; or (2) they may have been qualified or limited by exceptions or other disclosures made to the other parties to the agreements in connection with the negotiation of those agreements, which exceptions and other disclosures may not be reflected in the agreements.
Exhibit
Description of Exhibit
3.1
Amended and Restated Certificate of Incorporation of Vision-Sciences, Inc. (Incorporated herein by reference to Exhibit 3.1 to the Registrant’s Registration Statement on Form S-3/A filed with the Securities and Exchange Commission on January 24, 2012).
3.2
Amended and Restated By-Laws of Vision-Sciences, Inc. (Incorporated herein by reference to Exhibit 3.2 to the Registrant’s Registration Statement on Form S-3 filed with the Securities and Exchange Commission on December 30, 2011.)
*10.1
2003 Director Option Plan, as amended (Incorporated by reference to the Registration Statement on Form S-8 filed on October 10, 2008).
*10.2
2000 Stock Incentive Plan (Incorporated by reference to the Annual Report on Form 10-K for the fiscal year ended March 31, 2000).
*10.3
2007 Stock Incentive Plan, as amended (Incorporated by reference to the Proxy Statement dated July 30, 2007 filed with the Securities and Exchange Commission on July 27, 2007 on Schedule 14A).
10.4
Separation Agreement between the Company and Ron Hadani dated November 9, 2009 (Incorporated by reference to the Quarterly Report on Form 10-Q for the quarter ended December 31, 2009).
10.5
License Agreement between Vision-Sciences, Inc. and Advanced Polymers, Inc. dated June 10, 1993 (Incorporated by reference to the Quarterly Report on Form 10-Q for the quarter ended June 30, 1993).
10.6
Amendment to License Agreement between Vision-Sciences, Inc. and Advanced Polymers, Inc. dated April 5, 1994 (Incorporated by reference to the Quarterly Report on Form 10-Q/A for the quarter ended June 30, 1994).
10.7
Amendment to License Agreement between Vision-Sciences, Inc. and Advanced Polymers, Inc. dated April 5, 1995 (Incorporated by reference to the Annual Report on Form 10-K for the fiscal year ended March 31, 1996).
10.8
Amendment to License Agreement between Vision-Sciences, Inc. and Advanced Polymers, Inc. dated April 5, 1996 (Incorporated by reference to the Annual Report on Form 10-K for the fiscal year ended March 31, 1996).
10.9
Lease Agreement between Vision-Sciences, Inc. and 30 Ramland Road LLC dated as of March 23, 2000 (Incorporated by reference to the Annual Report on Form 10-K for the fiscal year ended March 31, 2000).
10.10
License Agreement between Vision-Sciences, Inc. and Medtronic Xomed, Inc. dated March 26, 2007 (Incorporated by reference to the Proxy Statement dated March 6, 2007 filed with the Securities and Exchange Commission on March 7, 2007 on Schedule 14A).
10.11
Third Amendment to Lease between Vision-Sciences, Inc. and 30 Ramland Road, LLC dated as December 26, 2006 (Incorporated by reference to the Annual Report on Form 10-K for the fiscal year ended March 31, 2008).
10.12
Development and Supply Agreement between Vision-Sciences, Inc. and SpineView, Inc. dated June 19, 2008 (Incorporated by reference to the Current Report on Form 8-K filed on June 23, 2008).
*10.13
Employment Letter between Vision-Sciences, Inc. and Katherine L. Wolf dated September 16, 2008 (Incorporated by reference to the Current Report on Form 8-K filed on September 16, 2008).
*10.14
Consulting Agreement between Vision-Sciences, Inc. and Warren Bielke dated April 7, 2009 (Incorporated by reference to the Annual Report on Form 10-K for the fiscal year ended March 31, 2009).
10.15
Fourth Amendment to Lease between Vision-Sciences, Inc. and 30 Ramland Road, LLC dated as April 12, 2009 (Incorporated by reference to the Annual Report on Form 10-K for the fiscal year ended March 31, 2009).
10.16
Amended and Restated Revolving Loan Agreement between Vision-Sciences, Inc. and Lewis C. Pell dated September 30, 2011 (Incorporated by reference to the Current Report on Form 8-k filed on October 4, 2012).
10.17
Common Stock Warrants of Vision-Sciences, Inc. issued to Lewis C. Pell dated November 9, 2009 (Incorporated by reference to the Quarterly Report on Form 10-Q for the quarter ended September 30, 2009).
10.18
Form of Common Stock Purchase Agreement dated January 18, 2011 (Incorporated by reference to the Current Report on Form 8-K filed on January 19, 2011).
**10.19
Supply Agreement between Vision-Sciences, Inc. and Stryker Corporation dated September 22, 2010 (Incorporated by reference to the Current Report on Form 8-K filed on September 28, 2010).
10.20
Purchase Agreement between Vision-Sciences, Inc. and Lincoln Park Capital Fund, LLC dated April 27, 2012 (Incorporated by reference to the Current Report on Form 8-K filed on April 27, 2012).
10.21
Common Stock Warrants of Vision-Sciences, Inc. issued to Lewis C. Pell dated September 30, 2011 (Incorporated by reference to the Current Report on Form 8-K filed on October 4, 2012).
10.22
Amendment to Separation Agreement between the Company and Ron Hadani dated March 14, 2012 (Incorporated by reference to the Current Report on Form 8-K filed on March 14, 2012).
10.23
Promissory Note between Vision-Sciences, Inc. and Lewis C. Pell dated July 25, 2012 (incorporated by reference to Exhibit 10.1 to Form 10-Q for the quarter ended June 30, 2012 as filed with the SEC on August 14, 2012).
10.24
Letter Agreement between Vision-Sciences, Inc. and Lewis C. Pell dated August 14, 2012 (incorporated by reference to Exhibit 10.2 to Form 10-Q for the quarter ended June 30, 2012 as filed with the SEC on August 14, 2012).
10.25
Waiver from Lewis C. Pell under the Revolving Loan Agreement dated April 27, 2012 (incorporated by reference to Exhibit 10.3 to Form 10-Q for the quarter ended June 30, 2012 as filed with the SEC on August 14, 2012).
10.26
Convertible Promissory Note made by Vision-Sciences, Inc. in favor of Lewis C. Pell, dated as of September 19, 2012 (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K, filed with the SEC on September 20, 2012).
*10.27
Employment Letter dated August 4, 2009 between the Company and Keith Darragh (incorporated by reference to Exhibit 10.2 to Form 10-Q for the quarter ended September 30, 2012 as filed with the SEC on November 5, 2012).
*10.28
Amended Employment Letter dated August 28, 2012 between the Company and Keith Darragh (incorporated by reference to Exhibit 10.3 to Form 10-Q for the quarter ended September 30, 2012 as filed with the SEC on November 5, 2012).
*10.29
Separation and Release Agreement dated August 28, 2012 between the Company and Katherine Wolf (incorporated by reference to Exhibit 10.4 to Form 10-Q for the quarter ended September 30, 2012 as filed with the SEC on November 5, 2012).
#10.30
Letter Agreement date June 21, 2013 between Company and Lewis C. Pell.
21.1
Subsidiaries of the Company
23.1
Consent of EisnerAmper, LLP
31.1
Certification of Chief Executive Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a), promulgated under the Securities Exchange Act of 1934, as amended
31.2
Certification of Principal Financial Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a), promulgated under the Securities Exchange Act of 1934, as amended
Certification of Chief Executive Officer and Principal Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
***101.INS
XBRL Instance
***101.SCH
XBRL Taxonomy Extension Schema
***101.CAL
XBRL Taxonomy Extension Calculation
***101.DEF
XBRL Taxonomy Extension Definition
***101.LAB
XBRL Taxonomy Extension Labels
***101.PRE
XBRL Taxonomy Extension Presentation
*
Management contract or compensatory plan or arrangement filed as an exhibit to this Form pursuant to Items 15(a) and 15(b) of Form 10-K.
**
Confidential treatment granted as to certain portions, which portions have been deleted and filed separately with the Securities and Exchange Commission.
***
XBRL information is furnished and not filed or a part of a registration statement or prospectus for purposes of sections 11 or 12 of the Securities Act of 1933, as amended, is deemed not filed for purposes of section 18 of the Securities Exchange Act of 1934, as amended, and otherwise is not subject to liability under these sections.
# Filed herewith.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
Signature
Title
Date
/s/ Lewis C. Pell
Chairman of the Board of Directors (Principal Executive Officer)
June 24, 2013
Lewis C. Pell
/s/ Keith J.C. Darragh
Interim Principal Financial and Accounting Officer
June 24, 2013
Keith J.C. Darragh
Director
June 24, 2013
Cynthia F. Ansari
/s/ David W. Anderson
Director
June 24, 2013
David W. Anderson
/s/ Warren Bielke
Director
June 24, 2013
Warren Bielke
/s/ Lothar Koob
Director
June 24, 2013
Lothar Koob
/s/ Katsumi Oneda
Director
June 24, 2013
Katsumi Oneda
/s/ Cheryl Pegus
Director
June 24, 2013
Cheryl Pegus
/s/ Bruce Polsky
Director
June 24, 2013
Bruce Polsky
/s/ John J. Rydzewski
Director
June 24, 2013
John J. Rydzewski
VISION-SCIENCES, INC. AND SUBSIDIARIES
Index to Consolidated Financial Statements
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders
Vision-Sciences, Inc.
We have audited the accompanying consolidated balance sheets of Vision-Sciences, Inc. and subsidiaries as of March 31, 2013 and 2012 and the related consolidated statements of operations, stockholders’ equity (deficit) and cash flows for the years then ended. The financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Vision-Sciences, Inc. and subsidiaries as of March 31, 2013 and 2012, and the consolidated results of their operations and their cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America.
/s/ EisnerAmper LLP
Edison, New Jersey
June 24, 2013
VISION-SCIENCES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
See notes to consolidated financial statements
VISION-SCIENCES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except per share amounts)
See notes to consolidated financial statements
VISION-SCIENCES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (DEFICIT)
(In thousands, except per share amounts)
See notes to consolidated financial statements
VISION-SCIENCES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
See notes to consolidated financial statements
VISION-SCIENCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except per share amounts)
Note 1. The Company and Summary of Significant Accounting Policies
Company Overview
Vision-Sciences, Inc. and its subsidiaries (the “Company,” which may be referred to as “our”, “us”, or “we”) designs, develops, manufactures, and markets products for endoscopy - the science of using an instrument, known as an endoscope to provide minimally invasive access to areas not readily visible to the human eye. Our products are sold throughout the world through direct sales representatives in the United States (“U.S.”) and independent distributors for the rest of the world. With respect to our urology products, we are the exclusive supplier to the Endoscopy Division of Stryker Corporation (“Stryker”). Our largest geographic markets are the U.S. and Europe.
We were incorporated in Delaware, and are the successor to operations originally begun in 1987. In December 1990, Machida Incorporated (“Machida”) became our wholly-owned subsidiary. We own the registered trademarks Vision Sciences®, Slide-On®, EndoSheath®, EndoWipe® and The Vision System®. Not all products referenced in this report are approved or cleared for sale, distribution, or use.
We have two reportable segments, medical and industrial. Each of these operating segments has unique characteristics and faces different opportunities and challenges.
Our medical segment designs, manufactures and sells our advanced line of endoscopy-based products, including our flexible endoscopes, and our EndoSheath technology referred to as a sheath or EndoSheath disposable, for a variety of specialties and markets.
Our industrial segment, through our wholly-owned subsidiary Machida, designs, manufactures, and sells borescopes to a variety of users, primarily in the aircraft engine manufacturing and aircraft engine maintenance industries. A borescope is an instrument that uses optical fibers for the visual inspection of narrow cavities. Our borescopes are used to inspect aircraft engines, casting parts and ground turbines, among other items.
Liquidity and Capital Resources
We have incurred substantial operating losses since our inception and there can be no assurance that we will ever achieve or sustain a profitable level of operations in the future. We anticipate that we will continue to incur negative cash flows from operations during fiscal 2014, driven by continued investment in a direct sales force for the U.S. market, spending for marketing, and general business operations. As of March 31, 2013, we had cash and cash equivalents totaling approximately $0.8 million. We expect that our cash at March 31, 2013, together with the $3 million of capital available under a convertible note dated September 19, 2012 and $5.0 million of capital to be made available to us, subject to certain conditions, under a letter agreement dated June 21, 2013 from Lewis C. Pell, our Chairman (see Note 13. Subsequent Event for additional information), should be sufficient to fund our operations through at least March 31, 2014. However, if our performance expectations fall short (including our failure to generate expected levels of sales) or our expenses exceed expectations, we will need to secure additional financing and/or reduce our expenses to continue our operations. Our failure to do so would have a material adverse impact on our prospects and financial condition. There can be no assurance that any contemplated additional financing will be available on terms acceptable to us, if at all. If required, we believe we would be able to reduce our expenses to a sufficient level to continue to operate as a going concern.
Principles of Consolidation
The consolidated financial statements include the accounts of Vision-Sciences, Inc. and its wholly-owned subsidiaries. All intercompany balances and transactions have been eliminated.
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. The most significant of which relate to the allowance for doubtful accounts, market value for inventories, warranties, and fair value of equity based instruments. Actual results could differ from those estimates.
VISION-SCIENCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except per share amounts)
Revenue Recognition
We recognize revenue in accordance with the Financial Accounting Standards Board (the “FASB”) Accounting Standards Codification (“ASC”) 605 (Topic 605, Revenue Recognition). ASC 605 requires that five basic criteria must be met before revenue can be recognized: (i) persuasive evidence that an arrangement exists; (ii) delivery has occurred or services were rendered; (iii) the fee is fixed and determinable; (iv) collectability is reasonably assured; and (v) the fair value of undelivered elements, if any, exists. Determination of criterion (iv) above is based on management’s judgment regarding the collectability of invoices for products and services delivered to customers. Should changes in conditions cause management to determine this criterion is not met for certain future transactions, revenue recognized for any reporting period could be adversely affected. We recognize revenue when title passes to the customer, generally upon shipment of our products F.O.B. shipping point. Revenue for service repairs of equipment is recognized after service has been completed, and service contract revenue is recognized ratably over the term of the contract.
For products sold to Stryker we recognize revenue in a two-step process. The first step is recognition of revenue for our cost to manufacture these products when title passes to Stryker, generally upon shipment of our products F.O.B. shipping point. The second step is recognition of revenue for our specified margin of Stryker’s gross profit after Stryker sells the products to their end customers, based upon reports received from Stryker monthly. There is no required minimum amount of scopes and EndoSheath products which Stryker is required to purchase from us.
Research and Development Expenses
Costs of research, new product development, and product redesign are charged to expense as incurred.
Stock-Based Compensation
We account for stock-based awards issued to employees in accordance with the provisions of ASC 718 (Topic 718, Compensation - Stock Compensation). We recognize stock-based compensation expense on a straight-line uniform basis over the service period of the award, which is generally four years for employees. We use historical data to estimate expected employee behaviors related to option exercises and forfeitures and include these expected forfeitures as a part of the estimate of stock-based compensation expense as of the grant date. For stock-based awards with performance-based vesting conditions, we are also required to estimate the probability of the vesting conditions being met. Stock-based awards issued to consultants are accounted for in accordance with the provisions of ASC 718 and ASC 505-50 (Subtopic 50 “Equity-Based Payments to Non-Employees” of Topic 505, Equity). Options granted to consultants are periodically revalued as the options vest, and are recognized as an expense over the related period of service or the vesting period, whichever is longer.
Income Taxes
We account for income taxes in accordance with the provisions of ASC 740 (Topic 740, Income Taxes). ASC 740 prescribes that the use of the liability method be used for income taxes. Under this method, deferred tax assets and liabilities are determined based on differences between the financial reporting and tax basis of assets and liabilities and are measured using enacted tax rates and laws that are expected to be in effect when the differences reverse. Any resulting net deferred tax assets are evaluated for recoverability and, accordingly, a valuation allowance is provided when it is more likely than not that all or some portion of the deferred tax asset will not be realized.
ASC Topic 740 also clarifies the accounting for uncertainty in income taxes recognized in the financial statements. This interpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken, or expected to be taken, in a tax return.
Additionally, ASC Topic 740 provides guidance on the recognition of interest and penalties related to income taxes. We have elected to treat interest and penalties, to the extent they arise, as a component of income taxes.
Foreign Currency Transactions
We charge foreign currency transaction gains or losses in connection with our purchases of products from foreign vendors to operations. For each of the fiscal years presented these amounts were immaterial.
VISION-SCIENCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except per share amounts)
Basic and Diluted Net Loss per Common Share
Basic net loss per share is calculated by dividing the net loss by the weighted average number of common shares outstanding. For all periods presented, the diluted net loss per common share is the same as basic net loss per common share, as the inclusion of other shares of stock issuable pursuant to stock options, warrants, and convertible debt would be anti-dilutive. The following table summarizes equity securities that were excluded from the calculation of fully diluted loss per share as of March 31, 2013 and 2012:
Concentration of Credit Risk
Concentration of credit risk with respect to accounts receivable relates to certain domestic and international customers to whom we make substantial sales. To reduce risk, we routinely assess the financial strength of our customers and, when appropriate, we obtain advance payments for our international sales. As a consequence, we believe that our accounts receivable credit risk exposure is limited. We maintain an allowance for potential credit losses, but historically we have not experienced any significant credit losses related to any individual customer or group of customers in any particular industry or geographic area.
The following table summarizes net sales to our significant customers, which accounted for more than 10% of total segment net sales and total accounts receivable, net:
Cash and Cash Equivalents
We classify investments with original maturities of 90 days or less, consisting of certificates of deposits and a money market account at a bank, as cash equivalents. Cash and cash equivalents consisted of cash and money market accounts at March 31, 2013 and 2012.
Fair Value Measurements
The carrying amounts reflected in our consolidated balance sheets for cash and cash equivalents, accounts receivable, other current assets, accounts payable, accrued expenses, accrued compensation, and capital lease obligations approximate fair value due to their short-term nature.
VISION-SCIENCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except per share amounts)
In determining the fair value of the convertible debt, we analyzed its attributes (coupon rate, conversion price, and the percentage of market cap the face value of the debt instrument was prior to the announcement of the debt) to public company convertible debt issuances from June 2011 through September 2012 (a sixteen (16) month period) in the healthcare industry. We determined the convertible debt was not issued at a discount as its fair value was equal to its face (carrying) value.
Allowance for Doubtful Accounts
We maintain an allowance for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. This allowance is used to report trade receivables at estimated net realizable value. We rely on prior experience to estimate cash that ultimately will be collected from the gross receivables balance at period-end. We maintain a specific allowance for customer accounts that will likely not be collectible due to customer liquidity issues. We also maintain an allowance for estimated future collection losses on existing receivables, determined based on historical trends.
Inventories
Inventories are stated at the lower of cost or market using the first-in, first-out (“FIFO”) method. If cost exceeds market, inventory is reported at its estimated fair market value based upon our historical experience with inventory becoming obsolete due to age, changes in technology, and other factors. We record a write-down for inventories of components that have become obsolete, slow moving, or are in excess of anticipated demand or net realizable value. We perform a detailed review of inventory each fiscal quarter that considers multiple factors, including demand forecasts, product life cycle status, product development plans, and current sales levels. Inventories consist of the following:
Raw materials include components purchased from independent suppliers. Most purchased components are available from multiple sources, with the exception of certain key components that are supplied to us by key suppliers, with whom we have long-term supply arrangements, but no long-term supply agreements.
Property and Equipment
Property and equipment are stated at cost less accumulated depreciation and amortization. Additions and improvements are capitalized, while maintenance and repairs are expensed as incurred. Asset and accumulated depreciation accounts are relieved for dispositions, with resulting gains or losses reflected in the statement of operations. Certain products used as sales demonstration and service loaner equipment are transferred from inventory to machinery and equipment and depreciated over 3 years.
Depreciation of property and equipment is provided using the straight-line method over the estimated useful lives of the various assets, or for leasehold improvements, over the term of the lease, if shorter. The estimated useful lives for each major asset classification are as follows:
Depreciation and amortization expense was $795 thousand and $832 thousand in fiscal years 2013 and 2012, respectively.
VISION-SCIENCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except per share amounts)
Other Assets
Other assets consist primarily of deposits and patents. Patents are amortized on a straight-line basis over a period of up to 15 years. Our patents were fully amortized at March 31, 2012.
Long-Lived Assets
We review the carrying values of our long-lived assets for possible impairment whenever events or changes in circumstances indicate that the carrying amounts of the assets may not be recoverable. We believe that the carrying value of these assets is fully realizable at March 31, 2013 and 2012.
Deferred Debt Cost
We defer costs, including the fair value of commitment warrants, associated with securing a line of credit or revolving loan agreement over the applicable term to maturity of the agreement. These costs are amortized as debt cost expense in our consolidated statement of operations. The costs are amortized over the term of the line of credit or revolving loan agreement on a straight-line basis or using the effective interest method.
The following table summarizes the components of gross and net deferred debt cost balances as of March 31, 2013 and 2012:
Warranty Obligations
We provide warranty on all of our products. We estimate the costs that may be incurred under warranties and record a liability in the amount of such costs at the time the product is sold. Factors that affect our warranty liability include the number of units sold, historical and anticipated rates of warranty claims, and cost per claim. We periodically assess the adequacy of our recorded warranty liabilities and adjust the amounts as necessary. Warranty expense is recorded in cost of sales in our statement of operations.
The following table summarizes changes in our warranty reserve for fiscal years 2013 and 2012:
The warranty reserve at March 31, 2013 and 2012 is included in accrued expenses in our consolidated balance sheets.
VISION-SCIENCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except per share amounts)
Note 2. Employee Savings Plan
We have a savings plan in the U.S. that qualifies under Section 401(k) of the IRC. Participating U.S. employees may contribute up to 70% of their salary, but not more than statutory limits. We may, but are not obligated to, make a matching contribution up to a certain percentage of each employee’s contribution. Matching contributions are invested proportionate to each participant’s voluntary contributions in the investment options provided under the plan. We did not make any matching contributions in fiscal years 2013 and 2012.
Note 3. Segment Information
We design, develop, manufacture, and market products for endoscopy in two reportable segments, medical and industrial.
Management evaluates the revenue and profitability performance of each of our segments to make operating and strategic decisions. We have no intersegment revenue.
The following table presents the reconciliation of loss before provision for income taxes:
VISION-SCIENCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except per share amounts)
The following table presents net sales based on the geographic location of the external customer. No individual foreign country accounted for more than 10% of our worldwide net sales in fiscal years 2013 and 2012.
Note 4. Income Taxes
We account for income taxes in accordance with ASC 740 (Topic 740, Income Taxes). ASC 740 is an asset and liability approach that requires the recognition of deferred tax assets and liabilities for the expected tax consequences or events that have been recognized in our financial statements or tax returns. ASC Topic 740 also clarifies the accounting for uncertainty in income taxes recognized in the financial statements. This interpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken, or expected to be taken, in a tax return. There were no significant matters determined to be unrecognized tax benefits taken or expected to be taken in a tax return that have been recorded in our consolidated financial statements for fiscal years 2013 and 2012.
Additionally, ASC Topic 740 provides guidance on the recognition of interest and penalties related to income taxes. There were no interest or penalties related to income taxes that have been accrued or recognized as of and for fiscal years 2013 and 2012. We have elected to treat interest and penalties, to the extent they arise, as a component of selling, general, and administrative expenses in our consolidated statement of operations.
In fiscal years 2013 and 2012, we recorded an income tax provision of approximately $12 thousand and $1 thousand, respectively, for minimum state taxes.
The reconciliation of the effective income tax rate to the federal statutory rate is as follows:
VISION-SCIENCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except per share amounts)
As of March 31, 2013, we had approximately $66.1 million of federal net operating loss carryforwards in the U.S. These net operating loss carryforwards expire at various dates through our fiscal 2033, commencing in fiscal 2014. We had $2.4 million of federal net operating loss carryforwards expire in fiscal 2013. As of March 31, 2013, we had approximately $41.7 million of state net operating loss carryforwards in the U.S. These net operating loss carryforwards expire at various dates through our fiscal 2028, commencing in fiscal 2014. We had $7.9 million state net operating loss carryforwards expire in fiscal 2013. At March 31, 2013, we had approximately $19 thousand of capital loss carryforwards available to offset future capital gains. These capital loss carryforwards expire in fiscal 2015. The Internal Revenue Code (“IRC”) limits the amounts of net operating loss carryforwards that a company may use in any one year in the event of certain cumulative changes in ownership over a three-year period as described in Section 382 of the IRC. We have not performed a detailed analysis to determine whether an ownership change has occurred. Such a change of ownership could limit our utilization of the net operating losses, and could be triggered by subsequent sales of securities by us or our stockholders.
The tax effects of the major items recorded as deferred tax assets are as follows:
The ending balances of the deferred tax asset have been fully reserved, reflecting the uncertainties as to realizability evidenced by our historical results and restrictions on the usage of the net operating loss carryforwards. We increased the valuation allowance by $2.1 million in fiscal 2013 to account for the change in the gross deferred tax asset.
We file tax returns in the U.S. federal jurisdiction and various states. We are no longer subject to U.S. federal tax examinations for years before our fiscal 2009 with exception of the net operating losses, for which the statute of limitations will expire the earlier of three years after the utilization or when expired. State jurisdictions that remain subject to examination range from our fiscal year 2010 to 2012.
VISION-SCIENCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except per share amounts)
Note 5. Accrued Expenses
The following table shows our consolidated financial statement details as of March 31, 2013 and 2012:
Note 6. Advances from Customers
Under a three-year agreement with Stryker expiring in April 2014, we are the exclusive supplier of Stryker-branded flexible video and fiber cystoscopes. These cystoscopes employ our patented EndoSheath technology, which are co-branded Stryker and Vision-Sciences. We also supply Stryker with flexible ureteroscopes under an agreement expiring in December 2015. Stryker has the exclusive rights to distribute products we manufacture, including cystoscopes, urology EndoSheath technology, and ureteroscopes, in North America, South America, Latin America, China, and Japan. Although Stryker was to receive the exclusive rights for the rest of the world in April 2012, we reached an agreement with Stryker to delay this launch indefinitely.
We also have a development and supply agreement with SpineView, Inc. (“SpineView”) under which we developed and supply a charge-coupled device (CCD) based video surgical endoscope for use with SpineView’s products.
We received advances from Stryker for future orders of our scopes and EndoSheath technology in September 2010 and March 2011 and from SpineView for the initial stocking order of 50 SpineView surgical endoscope systems in September 2010. All of the advances were fully utilized as of September 30, 2012. The following table summarizes the activity related to these and other customer advances related to service contracts for fiscal years 2013 and 2012:
(1)
Amount reclassified to deferred revenue
VISION-SCIENCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except per share amounts)
Note 7. Long-Term Debt - Related Party
On September 19, 2012 (the “Effective Date”), we entered into a new $20.0 million revolving convertible promissory note (the “Replacement Note”) with our chairman, Lewis C. Pell (the “Lender”). The Replacement Note consolidated and restructured the $15.0 million in aggregate borrowings collectively outstanding under the Original Agreement (as defined below) and the Supplemental Note (as defined below) and provided for an additional $5.0 million available to us (of which $2.0 million has been drawn as of March 31, 2013). As we draw upon the remaining $3.0 million, a beneficial conversion feature will be recorded if the market price of our common stock increases after the Effective Date. We also terminated the letter agreement dated August 14, 2012, pursuant to which Mr. Pell had agreed to provide financial assistance to us in the amount of up to $3.0 million.
The Replacement Note accrues annual interest, payable annually, at the rate of 0.84%. The Replacement Note must be repaid in full on or before its fifth anniversary (the “Maturity Date”), but may be prepaid by us at any time without penalty. We will be required to repay all amounts outstanding under the Replacement Note upon an event of default, as defined in the Replacement Note.
The outstanding principal amount of the Replacement Note is convertible at any time prior to the Maturity Date, at Mr. Pell’s option, into shares of our common stock at a conversion price of $1.20 per share, which was the closing price of our common stock on the Effective Date.
The Replacement Note replaces the original loan agreement between us and Mr. Pell dated September 30, 2011 (the “Original Agreement”) pursuant to which we borrowed $10.0 million, and the promissory note of $5.0 million dated July 25, 2012 (the “Supplemental Note”) pursuant to which we borrowed $5.0 million. The amounts borrowed against the Original Agreement and Supplemental Note accrued interest at an annual rate of 7.5%. Mr. Pell also had received an availability fee equal to an annual rate of 0.5% on the difference between the average annual principal amount of the outstanding balance under the Original Agreement and the maximum amount of $10.0 million.
In connection with the Original Agreement, Mr. Pell received warrants to purchase an aggregate of 1,880,620 shares of our common stock at a weighted average exercise price of $1.86 per share. All of the warrants are vested and outstanding as of March 31, 2013 and expire on September 30, 2016.
We estimated the fair value of all of the stock warrants issued on the date of vesting using a Black-Scholes valuation model that used the weighted average assumptions for the risk-free interest rate, expected life (in years), and expected volatility. We recorded the transaction as a deferred debt cost, which is amortized to expense over the term of the loan. The following table summarizes amounts drawn against the Original Agreement and warrant issuances:
(1)
Includes the incremental fair value of $73 thousand arising from the extension of the maturity date of the original (previously issued) warrants.
VISION-SCIENCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except per share amounts)
In connection with the termination of the Original Agreement, we determined that the transaction should be classified as an extinguishment of debt. Accordingly, we wrote-off the remaining deferred debt cost balance of $1.2 million at September 19, 2012.
Debt cost expense and interest expense related to the stock warrants and availability fee and accrued interest on outstanding borrowings, respectively, for fiscal years 2013 and 2012 were recorded in our consolidated statement of operations as follows:
(1)
Expense through September 19, 2012.
At March 31, 2013, we had $17.0 million in outstanding borrowings under the Replacement Note, which is reflected as convertible debt - related party on our consolidated balance sheet. We had $70 thousand in accrued interest related to the Replacement Note, which is included in accrued expenses on our consolidated balance sheet at March 31, 2013.
Note 8. Commitments and Contingencies
Leases
We rent our facilities in Orangeburg, NY (“Orangeburg”) and Natick, MA (“Natick”) from non-related parties. We occupy 20,500 square feet in our facility in Orangeburg under a lease, amended in April 2009, which expires in August 2015. Our Natick facility occupies 9,835 square feet under a lease, amended in April 2012, which expires in June 2014. We also lease some office and production equipment under leases that expire in August 2014.
The following table summarizes the future minimum lease commitments under all operating and capital leases as of March 31, 2013:
Total rent expense was approximately $496 thousand and $462 thousand in fiscal years 2013 and 2012, respectively. Certain of our leases contain purchase and/or renewal options.
Litigation
As of March 31, 2013, we had no material legal proceedings to which we, or any of our subsidiaries, are a party or to which any of our properties are subject.
VISION-SCIENCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except per share amounts)
Note 9. Common Stock
On April 27, 2012, we entered into a purchase agreement (the “Purchase Agreement”) with Lincoln Park Capital Fund, LLC (“LPC”), pursuant to which we have the right to sell to LPC up to $15.0 million in shares of our common stock from time-to-time over a period of up to three years, subject to certain limitations and conditions set forth in the Purchase Agreement. This total maximum amount of $15.0 million would increase to $21.0 million if the aggregate market value of shares of our common stock held by non-affiliates reached at least $75.0 million during the three-year term of the Purchase Agreement. The Purchase Agreement contains customary representations, warranties and agreements between us and LPC, limitations (market price of our common stock and LPC’s ownership limit) and conditions to completing future sale transactions, indemnification rights and other obligations of the parties. In connection with the initial purchase under the Purchase Agreement, and any future sales under the Purchase Agreement, Mr. Pell waived the repayment requirement under the Loan Agreement. On July 26, 2012, we amended the Purchase Agreement with LPC to, among other things, create a threshold price of $3.00 for the sale of our common stock to LPC, as calculated pursuant to the formula provided in the Purchase Agreement.
As consideration for entering into the Purchase Agreement and for their initial purchase of $1.0 million of our common stock in April 2012, we issued to LPC 175,333 shares of our common stock. As consideration for any remaining future purchases under the Purchase Agreement, we also will issue to LPC, on a pro rata basis in connection with each purchase of shares by LPC, up to a total of approximately 215,000 additional shares of our common stock. We did not receive any cash proceeds from the issuance of 175,333 shares and will not receive any proceeds upon the issuance of any of the remaining 215,000 shares.
The following table summarizes the common stock issued and cash received in connection with the Purchase Agreement:
(1)
Calculated as follows: ($1.0 million stock purchase divided by $15.0 million total maximum amount) multiplied by 230,000 additional commitment shares.
In connection with the Purchase Agreement, we incurred $122 thousand of costs associated with investment banking fees, legal fees, and expense reimbursement to LPC. Our net proceeds from the sale of the initial purchase shares were $878 thousand.
Note 10. Stock-Based Awards
We maintain the following stockholder-approved equity incentive plans:
●
The 2000 Stock Incentive Plan (the “2000 Plan”) authorized the issuance of up to 4,500,000 shares of common stock covering several different types of awards, including stock options, restricted shares, stock appreciation rights, and performance shares.
●
The 2007 Stock Incentive Plan (the “2007 Plan”) authorized the issuance of up to 5,000,000 shares of common stock covering several different types of awards, including stock options, restricted shares, stock appreciation rights, and other stock-based awards. On July 26, 2012, our stockholders approved an amendment to the 2007 Plan further increasing the number of authorized shares issuable under the plan to 7,000,000 shares of common stock.
●
The 2003 Director Option Plan (the “2003 Plan”) authorized the issuance of up to 450,000 shares of common stock covering the annual automatic grant of 10,000 stock options per outside director per year. The 2003 Plan also provides for granting newly elected or appointed outside directors a one-time grant of 10,000 stock options.
VISION-SCIENCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except per share amounts)
The stock option plans provide that options may be granted at an exercise price of 100% of fair market value of our common stock on the date of grant, may be exercised in full or in installments, at the discretion of our Board or its Compensation Committee, and must be exercised within ten years from date of grant. We recognize stock-based compensation expense on a straight-line basis over the requisite service period based on fair values, generally four years. We use historical data to estimate expected employee behaviors related to option exercises and forfeitures and included these expected forfeitures as a part of the estimate of stock-based compensation expense as of the grant date.
Stock Options
The following table summarizes stock option activity for fiscal years 2013 and 2012:
Note 1: Due to cashless exercises in fiscal 2012, 706,149 common shares were received from the exercise of 1,954,715 stock options.
At March 31, 2013, there were 1,758,369 shares of common stock reserved for stock options. We generally issue shares for the exercise of stock options from unissued reserved shares.
The weighted average remaining contractual term was approximately 6.6 years for stock options outstanding, approximately 5.2 years for stock options exercisable, and 6.5 years for stock options vested and expected to vest as of March 31, 2013. The weighted average fair value of options granted was $0.90 and $1.63 in fiscal years 2013 and 2012, respectively.
The total intrinsic value (the excess of the market price over the exercise price) was approximately $55 thousand for stock options outstanding, $40 thousand for stock options exercisable, and $52 thousand for stock options vested and expected to vest as of March 31, 2013. The total intrinsic value for stock options exercised was approximately $25 thousand and $398 thousand in fiscal years 2013 and 2012, respectively.
We do not expect to realize any tax benefits from future disqualifying dispositions, if any, because we currently have a full valuation allowance against our deferred tax assets.
VISION-SCIENCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except per share amounts)
The following table summarizes information concerning outstanding and exercisable stock options at March 31, 2013:
Restricted Stock
We determine stock-based compensation expense for performance based restricted stock based upon the fair value of our common stock at the date of grant and recognize expense based upon the most probable outcome as to whether the performance targets will be achieved and the stock-based compensation being earned.
The following table summarizes restricted stock activity for fiscal years 2013 and 2012:
At March 31, 2012, the balance of 306,606 shares of nonvested restricted stock included 286,606 shares of restricted stock granted to management as part of our fiscal 2012 performance incentive plan (the “2012 PIP”). The 2012 PIP included two separate performance measures: (1) Company revenue and operating loss performance (the “Company Component”), which accounted for 75% of the target incentive opportunity, and (2) individual executive performance milestones (the “Individual Component”), which accounted for the remaining 25%.
For the Company Component of the 2012 PIP, management achieved 80% of our target revenue and specified operating loss level for fiscal 2012, and participants received 80% of their Company Component (equal to a total of 144,808 shares of restricted stock). For the Individual Component, management determined the level of payout for each participant based on the achievement of the individual’s executive performance milestones (with awards totaling 108,959 shares of restricted stock). For the aggregate 253,767 shares of restricted stock that were achieved, restrictions on those shares will lapse over a four-year period. The restrictions on the first one-fourth of the shares (equal to 48,656 shares) lapsed in April 2012. The balance of the restricted stock for the 2012 PIP (equal to 44,733 shares) was forfeited as a result of missed milestones and employee terminations.
VISION-SCIENCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except per share amounts)
Stock-Based Compensation Expense
We account for stock-based awards issued to employees in accordance with the provisions of ASC 718 (Topic 718, Compensation - Stock Compensation). We recognize stock-based compensation expense on a straight-line uniform basis over the service period of the award, which is generally four years for employees. Stock-based awards issued to consultants are accounted for in accordance with the provisions of ASC 718 and ASC 505-50 (Subtopic 50 “Equity-Based Payments to Non-Employees” of Topic 505, Equity). Options granted to consultants are periodically revalued as the options vest, and are recognized as an expense over the related period of service or the vesting period, whichever is longer. Under the provisions of ASC 718, members of the Board are considered employees for calculation of stock-based compensation expense.
We estimated the fair value of the stock options granted on the date of grant using a Black-Scholes valuation model that used the weighted average assumptions noted in the following table. The risk-free interest rate assumption we use is based upon United States Treasury interest rates appropriate for the expected life of the awards. The expected life (estimated period of time that we expect employees, consultants and directors to hold their stock options) was estimated based on historical rates for two group classifications, (i) employees and consultants and (ii) outside directors. Expected volatility was based on historical volatility of our stock price for a period equal to the stock option’s expected life and calculated on a daily basis. The expected dividend rate is zero since we do not currently pay cash dividends on our common stock and do not anticipate doing so in the foreseeable future.
The following table summarizes stock-based compensation recorded in our consolidated statements of operations in fiscal years 2013 and 2012:
At March 31, 2013, unrecognized stock-based compensation expense related to stock options was approximately $2.1 million and is expected to be recognized over a weighted average period of approximately 2.5 years. At March 31, 2013, unrecognized stock-based compensation expense related to nonvested (restricted stock) awards was approximately $0.2 million, which is expected to be recognized over a weighted average period of approximately 1.8 years.
VISION-SCIENCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except per share amounts)
Note 11. Treasury Stock
The following table summarizes treasury stock activity for fiscal years 2013 and 2012:
The shares were purchased from management employees to cover income tax withholdings upon the lapse of restrictions on their restricted stock awards. Although not required to under our equity incentive plans, we anticipate repurchasing shares in a similar arrangement during fiscal 2014.
Note 12. Quarterly Financial Data (Unaudited)
Note 13. Subsequent Event
Pursuant to a letter agreement dated June 21, 2013, Mr. Pell has agreed to provide financial assistance to us in the amount of up to $5.0 million, if necessary to support our operations, for a period ending on the earlier of (i) July 1, 2014 or (ii) our raising debt or equity capital in the amount of $5.0 million or more. This financial assistance, if drawn by us, would be on the same terms as our existing convertible debt with Mr. Pell.