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HRT > SEC Filings for HRT > Form 10-Q on 23-Nov-2012All Recent SEC Filings

Show all filings for ARRHYTHMIA RESEARCH TECHNOLOGY INC /DE/

Form 10-Q for ARRHYTHMIA RESEARCH TECHNOLOGY INC /DE/


23-Nov-2012

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Forward-Looking Statements
Any forward looking statements made herein are based on current expectations of the Company that involve a number of risks and uncertainties and should not be considered as guarantees of future performance. These statements are made under the Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements may be identified by the use of words such as "expect," "anticipate," "believe," "intend," "plans," "predict," or "will". Although the Company believes that our expectations are based on reasonable assumptions, we can give no assurance that our expectations will materialize. Many factors could cause actual results to differ materially from our forward-looking statements. Several of these factors include, without limitation: our ability to maintain our current pricing model and/or decrease our cost of sales; our ability to increase sales of higher margin products and services; variations in the mix of products and services sold; variability of customer delivery requirements; ability to license our software, provide timely customization and updates; a stable interest rate market and/or a stable currency rate environment in the world, and specifically the countries where we are doing business; continued availability of supplies or materials used in manufacturing at competitive prices; volatility in commodity and energy prices; the Company's ability to offset higher costs with price increases; adverse regulatory developments in the U.S. or any other country the Company plans to do business in; entrance of competitive products and services in the Company's markets; the ability of management to execute plans and motivate personnel in the execution of those plans; no adverse publicity related to the Company and/or its products; adverse claims relating to the Company's intellectual property; adoption of new, or changes in, accounting principles; passage of new, or changes in, regulations; legal proceedings; ability to maintain compliance with the NYSE MKT requirements for continued listing of our common stock; the costs inherent with complying with statutes and regulations applicable to public reporting companies, such as the Sarbanes-Oxley Act of 2002; and other risks referenced from time to time elsewhere in this report and in our filings with the SEC.
The Company is under no obligation and does not intend to update, revise or otherwise publicly release any revisions to these forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrence of any unanticipated events. More information about factors that potentially could affect the Company's financial results is included in the Company's filings with the SEC, including its Annual Report on Form 10-K for the year ended December 31, 2011.

Overview

Arrhythmia Research Technology, Inc. ("ART") is engaged in the development, sales, and licensing of medical software, which acquires data and analyzes electrical impulses of the heart to aid in the detection of potentially lethal arrhythmias. Micron Products, Inc. ("Micron"), a wholly owned subsidiary, is the primary source of consolidated revenues. This primary source of revenue relates to the manufacturing of components, devices and equipment primarily for the medical and defense industries. The single largest category of revenue relates to Micron's production and sale of silver/silver chloride coated and conductive resin sensors used as component parts in the manufacture of integrated disposable electrophysiological sensors. These disposable medical devices are used worldwide in the monitoring of electrical signals in various medical applications. In an effort to leverage these skills, the Company has expanded into custom thermoplastic injection molded products with a full array of design, engineering and production services and management. With the addition of a medical machining cell, the Company began production of patient specific metal and plastic orthopedic devices. Management continues to seek to identify complementary and/or synergistic products, technologies and lines of business in an effort to broaden the Company's offerings.
The Company discontinued its investment into and operation of a cardiac monitoring service provider previously referred to as WirelessDx. The brand WirelessDx included a Radnor, PA based wholly owned subsidiary named RMDDxUSA Corp. and its wholly owned Canadian subsidiary named RMDDx Corporation. The decision to discontinue and liquidate occurred in the three months ended September 30, 2012 and is expected to be completed by December 31, 2012. Results of Operations
Revenues
The Company's consolidated net sales for the three months ended September 30, 2012 were $4,839,812, a decrease of $1,917,038 or 28.4%, when compared to the total net sales of $6,756,850 in the three months ended September 30, 2011 as discussed by segment below.
Micron sales for the three months ended September 30, 2012 were $4,827,266, a decrease of $1,929,584 or 28.6%, when compared to sales of $6,756,850 in the same period in 2011. Micron's sensor volume was 23.9% lower over the same period last year due to reduced orders from existing customers. Silver surcharge billed was lower by 46.3% when compared to the same period in 2011. Custom manufacturing had increases in revenue as new programs began to have a positive impact in the period and are expected to continue their growth trend. ART's net sales were $12,546 for the three months ended September 30, 2012 compared to the net sales of $0 in the same period in 2011.


The Company's consolidated net sales for the nine months ended September 30, 2012 were $15,881,161, a decrease of $3,048,334 or 16.1%, when compared to the total net sales of $18,929,495 in the nine months ended September 30, 2011 as discussed by segment below.
Micron sales for the nine months ended September 30, 2012 were $15,856,975, a decrease of $3,072,520 or 16.2%, when compared to sales of $18,929,495 in the same period in 2011. Micron's sensor volume was 0.7% lower than the same period in 2011. The majority of the reduction in sensor revenue came from the reduction in the price of silver period over period reducing silver surcharge by 30.5%. The remaining reduction came from a decrease in custom manufacturing for the nine months ended September 30, 2012.
ART's net sales were $24,186 for the nine months ended September 30, 2012 compared to the net sales of $0 in the same period in 2011.
Revenue from domestic and foreign sales for the three and nine month periods is as follows:

                     Three months ended Sept 30,                  Nine months ended Sept 30,
                  2012        %         2011        %         2012         %         2011         %
United States $ 2,269,887     47    $ 2,539,318     38    $  6,651,973     42    $  7,433,753     39
Canada          1,214,272     25      2,031,183     30       4,659,454     29       6,388,472     34
Europe            292,525     6         764,403     11       1,332,569     8        1,924,825     10
Pacific Rim       553,559     11        888,691     13       1,538,307     10       1,731,345     9
Other             509,569     11        533,255     8        1,698,858     11       1,451,100     8
Total         $ 4,839,812    100%   $ 6,756,850    100%   $ 15,881,161    100%   $ 18,929,495    100%

The decrease of sales in Canada is from sensors and silver surcharge, while European sales were down in large part due to a customer being acquired and lower orders taking place in the third quarter as the companies integrated operations and inventories. The decrease of sales in the United States is related to a reduction in defense industry products, partially offset by an increase in medical products.
Cost of sales
The Company's consolidated cost of sales was $4,112,599 (85% of net sales) in the three months ended September 30, 2012 compared to $5,266,184 (78% of net sales) in the three months ended September 30, 2011, a decrease of $1,153,585 or 21.9% as discussed by segment below.
Micron's cost of sales was $4,112,599 (85.2% of segment sales) in the three months ended September 30, 2012 compared to $5,266,184 (77.9% of segment sales) in the same period in 2011, a decrease of $1,153,585 or 21.9%. Management routinely reviews its products and programs, including those in development, for contribution and value to our overall business strategy and results. Programs with unacceptable margins will be phased out or discontinued, so that Micron's resources will be used to develop those of greater strategic value. ART's cost of sales was $0 in the three months ended September 30, 2012 and the same period in 2011.
The Company's consolidated cost of sales was $13,106,456 (82.5% of net sales) in the nine months ended September 30, 2012 compared to $14,827,889 (78.3% of net sales) in the nine months ended September 30, 2011 a decrease of $1,721,433 or 11.6% as discussed by segment below. The decrease in the consolidated cost of sales is mainly due to the decrease in consolidated revenues.
Micron's cost of sales was $13,106,456 (82.7% of segment sales) in the nine months ended September 30, 2012 compared to $14,826,069 (78.3% of segment sales) in the same period in 2011 a decrease of $1,719,613 or 11.6%. The cost of silver has generally been passed on to our customers in the form of a surcharge. The surcharge protects Micron from decreasing gross profits from an increase in the cost of silver. This surcharge does not completely insulate Micron's inventory on hand from any dramatic change in value of silver. Management routinely reviews its products and programs, including those in development, for contribution and value to our overall business strategy and results. Programs with unacceptable margins will be phased out or discontinued, so that Micron's resources will be used to develop those of more strategic value. ART's cost of sales was $0 in the nine months ended September 30, 2012 and $1,820 in the same period in 2011.
Selling and marketing expenses
The Company's consolidated selling and marketing expense decreased to $186,178 (4% of net sales) in the three months ended September 30, 2012 from $196,768 (3% of net sales) in the same period in 2011, a decrease of $10,590, or 5% as discussed by segment below.
Micron's selling and marketing expense increased to $181,674 (4.5% of segment sales) in the three months ended September 30, 2012 from $155,870 (3.2% of segment sales) in the same period in 2011, an increase of $25,804. While Micron's


sales force remains stable, sales commissions in total have increased as new programs began to yield a higher percentage of products sold. The selling expense also included increased travel costs during the quarter. ART's selling and marketing expense decreased to $4,504 in the three months ended September 30, 2012 from $40,898 in in the same period in 2011, a decrease of $36,394, or 89.0%. In the three months ended September 30 2012, selling and travel expense were reduced as resources were temporarily assigned to other duties.
The Company's consolidated selling and marketing expense decreased to $692,272 (4% of net sales) in the nine months ended September 30, 2012 from $694,273 (4% of net sales) in the same period in 2011, a decrease of $2,001, or 0.3% as discussed by segment below.
Micron's selling and marketing expense increased to $585,872 (4.5% of segment sales) in the nine months ended September 30, 2012 from $558,845 (3.2% of segment sales) in the same period in 2011, an increase of $27,027. While Micron's sales force remains the same, sales commissions and travel have increased as new programs began.
ART's selling and marketing expense decreased to $106,400 in the nine months ended September 30, 2012 from $135,428 in the same period in 2011, a decrease of $29,028, or 21.4%. In 2012, expenses incurred were related to business development efforts for SAECG, including travel and trade show expenses. General and administrative expenses
The Company's consolidated general and administrative expense was $720,515 (14.9% of net sales) in the three months ended September 30, 2012 as compared to $657,021 (9.7% of net sales) in the same period in 2011, an increase of $63,494 or 9.7% as discussed by segment below.
Micron's general and administrative expense decreased to $180,680 (3.8% of net sales) in the three months ended September 30, 2012 from $207,262 (3.4% of net sales) in the same period in 2011, a decrease of $26,582. The decrease was related to lower legal expenses and amortization expense of intangible assets in comparing the quarter with the same period last year.
ART's general and administrative expense was $75,141 (1.6% of net sales) in the three months ended September 30, 2012 as compared to $118,594 (1.8% of net sales) in the same period in 2011, a decrease of $43,453. The decrease was due to lower travel expenses and legal work associated with contracts when comparing the quarter with the same period last year.
The Corporate segment increased to $464,694 (9.6% of net sales) in the three months ended September 30, 2012 from $331,165 (4.9% of net sales) in the same period in 2011, an increase of $133,529. A large portion of this increase was the cost associated with the increased compliance requirements including quarterly SEC filings. Other corporate and travel expenses also increased when compared to the comparable period.
The Company's consolidated general and administrative expense was $2,141,089 (13.5% of net sales) in the nine months ended September 30, 2012 as compared to $1,994,282 (10.5% of net sales) in the same period in 2011, an increase of $146,807 or 7.4% as discussed by segment below.
Micron's general and administrative expense decreased to $577,039 (3.6% of net sales) in the nine months ended September 30, 2012 from $632,214 (3.3% of net sales) in the same period in 2011, a decrease of $55,175. The decrease was related to lower legal expenses and amortization expense of intangible assets in comparing the nine month period with the same period last year.
ART's general and administrative expense was $234,478 (1.5% of net sales) in the nine months ended September 30, 2012 as compared to $297,403 (1.6% of net sales) in the same period in 2011, a decrease of $62,925. The decrease was related to lower travel expenses and legal work associated with contract negotiations when comparing the quarter with the same period last year.
The Corporate segment increased to $1,329,572 (8.4% of net sales) in the nine months ended September 30, 2012 from $1,064,665 (5.6% of net sales) in the same period in 2011, an increase of $264,907. A large portion of this increase was the cost associated with the increased compliance requirements with the year end and first quarter SEC filings. This cost is expected to continue, with the increased complexity of additional tax jurisdictions and increased legal and audit related expenses.
Research and development expenses
The Company's consolidated research and development costs increased to $115,034 (2.4% of net sales) in the three months ended September 30, 2012 from $99,173 (1.5% of net sales) in the same period in 2011, an increase of $15,861, or 16.0% as discussed by segment below.
Micron's research and development costs decreased to $38,466 (0.8% of net sales) in the three months ended September 30, 2012 from $49,651 (0.8% of net sales) in the same period in 2011, a decrease of $11,185, or 22.5%. The expense is related to process improvements on the Micron sensors and snap product lines as well as new processes and capabilities within MIT.
ART's research and development expenses increased to $76,568 (1.6% of net sales) in the three months ended September 30, 2012 from $49,522 (0.7% of net sales) in the same period in 2011. Research and development expense in 2012 included the addition of a full-time employee, and additional technical consulting for PREDICTOR. The 2011 expenses included the technical


support of a NIH research project utilizing ART's proprietary Signal Averaged ECG software and evaluation of other devices for software development. The Company's consolidated research and development costs increased to $380,266 (2.4% of net sales) in the nine months ended September 30, 2012 from $287,037 (1.5% of net sales) in the same period in 2011, an increase of $93,229, or 32.5% as discussed by segment below.
Micron's research and development costs decreased to $100,889 (0.9% of net sales) in the nine months ended September 30, 2012 from $145,911 (1.2% of net sales) in the same period in 2011, a decrease of $45,022, or 30.9%. The expense is related to process improvements on the Micron sensors and snap product lines as well as new processes and capabilities within MIT.
ART's research and development expenses increased to $279,377 (1.5% of net sales) in the nine months ended September 30, 2012 from $141,126 (1.6% of net sales) in the same period in 2011. Research and development expense in 2012 included the addition of a full-time employee, and additional technical consulting for PREDICTOR. The 2011 expenses included the technical support of a NIH research project utilizing ART's proprietary Signal Averaged ECG software and evaluation of other devices for software development. Goodwill Impairment
The Company accounts for goodwill and indefinite lived intangibles in accordance with ASC 350 "Intangibles - Goodwill and other". Goodwill is reviewed for impairment annually, or when events arise that could indicate that impairment exists. The provisions of ASC 350 require that the Company perform a two-step impairment test. In the first step, the Company compares the fair value of its reporting units to the carrying value of the reporting units. If the carrying value of the net assets assigned to the reporting units exceeds the fair value of the reporting units, then the second step of the impairment test is performed in order to determine the implied fair value of the reporting units' goodwill. If the carrying value of the reporting units' goodwill exceeds its implied fair value, an impairment loss equal to the difference is recorded.
On September 30, 2012, the Company analyzed whether the movement in the stock price constituted a "triggering event" for the purpose of goodwill testing. The Company performed a Step 1 analysis to see if goodwill should be impaired. The operating reporting unit failed the test and required impairment. As a result, the Company has preliminarily determined that the full value of its goodwill was impaired and has recorded in the third quarter of 2012 and estimated preliminary impairment charge of $1,479,727. Due to the timing and complexity of step 2 of the impairment test, which is required to determine the actual impairment, the Company was unable to finalize the amount of impairment prior to filing the form 10-Q for the quarter ended September 30, 2012. Step 2 of the impairment test will be completed in the fourth quarter of 2012. Any adjustment to the estimated impairment charge made in the third quarter of 2012 will be recorded in the fourth quarter of 2012.
Income tax benefit
Income tax benefit as a percentage of loss before income taxes was 17% for the three months ended September 30, 2012 as compared to an income tax benefit of 0% for the same period in 2011. For the nine months ended September 30, 2012, the effective rate of income tax benefit was 30% compared to an income tax expense of 9% for the same period in 2011. The tax benefit is calculated using a projected effective tax rate calculated with an estimated projected loss for the year and adjusting for permenant differences between book losses and tax losses and 2011 estimated to actual true-ups. The benefit expects to fully utilize net operating losses in the next three years. Management will continue to seek to implement any tax planning opportunities that could effectively reduce the Company's income tax obligations in the future.

Liquidity and Capital Resources
Working capital was $2,367,398 at September 30, 2012 compared to $6,118,677 at December 31, 2011, a decrease of $3,751,279. The majority of the working capital decreases related to cash investment during the nine months ended September 30, 2012 into the discontinued operations of WirelessDx. Capital investment may decrease working capital with any significant investment resulting from future acquisition of capital assets or businesses, significant expansion of production capacity, or further software and product development.
Net capital expenditures were $893,887 for the first nine months of 2012 as compared to $1,271,807 for the same period in 2011. The largest portion of the capital expenditures in the first nine months of 2012 resulted from the routine replacement of production equipment and tooling in the Micron manufacturing production lines. Capital expenditures for the nine months ended September 30, 2012 were made with cash on hand or the use of an equipment capital lease. The Company has a master lease agreement with its bank that allows for money to be drawn on standard terms for the purchase of equipment. During the nine months ended September 30, 2012, a total of $523,269 was drawn down to acquire production equipment for Micron and $888,649 for the discontinued operations capital equipment needs. At September 30, 2012, the current balance of these notes were $475,150 and $848,275, respectively. The term of these capital leases is five years.


The Company has a demand line of credit with a large multinational bank of $3 million dollars. The agreement provides for borrowings up to 80% of eligible accounts receivable plus 50% of raw material and finished goods inventories up to $700,000. This facility has no borrowing base charge. The agreement contains covenants on various matters including notice prior to executing further borrowings and security interests, merger or consolidation, acquisitions, guarantees, sales of assets other than in the normal course of business, leasing, changes in ownership and payment of dividends. At September 30, 2012, the outstanding balance was $800,000. Under this credit line, the Company has for the benefit of its discontinued operations secured a $1,000,000 letter of credit related to economic incentives and performance guarantees. During the the nine months ended September 30, 2012, the Board of Directors declared and paid a cash dividend of $0.03 per share for a total of $84,119. In the comparable period ended September 30, 2011, the Board of Directors declared and paid two cash dividends of $0.06 per share each for a total of $336,472. The Company has historically funded capital expenditures from operations, and more recently from borrowings under the line of credit and a capital equipment lease line. Management believes that as the Company needs to fund operations or capital expenditures, financing alternatives are available. Other Operating matters and liquidity
The Company has experienced net operating losses from June 2011 through September 30, 2012, including a net loss of $4.9 million for the nine months then ended. The Company has borrowings of $800,000 under its line of credit with a bank at September 30, 2012 and $880,000 of available funds under this line of credit based upon its borrowing base formula. Borrowings under the line of credit become due in April 2013.
In an effort to better control costs and overall operations, the Company decided to discontinue operations of its WirelessDx segment. For the nine months ended September 30, 2012, WirelessDx incurred a cash flow deficit of over $3 million. As the Company resumes its focus on its core business, Micron, further cost savings will be identified and cost savings actions will be implemented if necessary.
The Company expects that its current and anticipated financial resources, including the $880,000 available under its credit facility with its bank, are adequate to maintain current and planned operations through December 31, 2013. However, if the Company is not successful in generating sufficient revenues to fund its operations or if the Company is unable to obtain additional debt funding, it may not be able to fund operations beyond December 31, 2013. The Company expects to continue to expand its product offerings and extend the due date of its debt and improve sales with new and existing channels. The Company expects to meet its goals in these areas and generate the additional cash needed to fund operations into 2013 and beyond; however, there can be no assurance that it will be able to do so. The ability of the Company to realize the carrying value of its assets depends on its ability to successfully execute on its long-term business plan.
Critical Accounting Policies
The preparation of financial statements and related disclosures in conformity with U.S. generally accepted accounting principles requires management to make judgments, assumptions and estimates that affect the amounts reported. Certain of these significant accounting policies are considered to be critical accounting policies, as defined below.
A critical accounting policy is defined as one that is both material to the presentation of the Company's financial statements and requires management to make difficult, subjective, and complex judgments that could have a material effect on the Company's financial condition and results of operations. Specifically, critical accounting estimates have the following attributes: 1) the Company is required to make assumptions about matters that are highly uncertain at the time of the estimate; and 2) different estimates the Company could reasonably have used, or changes in the estimate that are reasonably likely to occur, would have a material effect on the Company's financial condition or results of operations.
Management believes that the following are critical accounting policies:
Revenue Recognition
The Company recognizes revenue upon product shipment or completion of patient monitoring services, provided that there exists persuasive evidence of an arrangement, the fee is fixed or determinable, and collectability of the related receivable is reasonably assured. Revenue from contracted commercial payers is recorded at the negotiated contractual rate. Accounts Receivable
Based on management's on-going analysis of accounts receivable balances, as to any event that adversely affects the ultimate ability to collect the related receivable, management will record an allowance for bad debts. Bad debts have not had a significant impact on the Company's financial position, results of operations and cash flows.


Stock-Based Compensation
The Company accounts for share based compensation under ASC 718, "Stock Compensation" ("ASC 718"). ASC 718 requires that companies recognize and measure compensation expense for all share-based payments at the grant date based on the fair market value of the award. This share-based compensation expense must be included in the Company's results of operations over the requisite service period.
The Company uses the Black-Scholes option pricing model which requires extensive use of financial estimates and accounting judgment, including the expected volatility of the Company's common stock over the estimated term, and estimates on the expected time period that employees will retain their vested options prior to exercising them. The use of alternative assumptions could produce significantly different estimates of the fair value of the stock-based compensation and as a result, provide significantly different amounts recognized in the Company's statements of comprehensive income (loss). Inventory
The Company values its inventory at the lower of average cost or net realizable value (FIFO). The Company reviews its inventory for quantities in excess of production requirements, obsolescence and for compliance with internal quality specifications. Any adjustments to inventory would be equal to the difference . . .

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