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CASM > SEC Filings for CASM > Form 10-K on 26-Mar-2013All Recent SEC Filings

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Form 10-K for CAS MEDICAL SYSTEMS INC


26-Mar-2013

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

Certain statements included in this report, including without limitation statements in the Management's Discussion and Analysis of Financial Condition and Results of Operations, which are not historical facts, are "forward looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These forward-looking statements represent the Company's current expectations regarding future events. The Company cautions that such statements are qualified by important factors that could cause actual results to differ materially from expected results which may be contained in the forward-looking statements. All forward-looking statements involve risks and uncertainties, including, but not limited to, the following: potential liquidity constraints; price and product competition; rapid technological changes; dependence on new product development; failure to introduce new products effectively or on a timely basis; the mix of products sold; supply and prices of raw materials and products; customer demand for the Company's products; regulatory actions; changes in reimbursement levels from third-party payors; product liability or other litigation claims; changes in economic conditions that adversely affect the level of demand for the Company's products; changes in foreign exchange markets; changes in financial markets; changes in the competitive environment; and other risks described in Item 1A of this filing.

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Overview

Over the last 12 months, specific accomplishments included:

? In July 2012, the Company secured a term loan of $3.5 million from East West Bank and a revolver of up to $2.5 million. As of December 31, 2012, the revolver remained undrawn.

? The Company recorded its best growth rate in more than three years with a 6% net revenue growth rate in the third quarter over the prior year period and increased that growth rate to 12% in the fourth quarter.

? The worldwide installed base of FORE-SIGHT monitors increased 35% during 2012 to 741 as of December 31, 2012.

? Total FORE-SIGHT revenues increased 23% led by a 43% growth in U.S. FORE-SIGHT sales.

? The Company continued to build on the base of clinical evidence for FORE-SIGHT. By August 2012, the Company surpassed the milestone of recording more than 200 publications referencing the performance of FORE-SIGHT monitoring.

The following discussion and analysis should be read together with our consolidated financial statements and related notes appearing elsewhere in this Annual Report on Form 10-K.

Year Ended December 31, 2012 Compared to Year Ended December 31, 2011

As a result of the sale of the Company's Statcorp business unit on November 5, 2010, those operations are classified as discontinued operations for all reported periods.

The Company recorded a net loss applicable to common stockholders of $8,432,000 for 2012 or ($0.63) per basic and diluted common share compared to a net loss applicable to common stockholders of $6,714,000, or ($0.51) per basic and diluted common share, for 2011. The loss from continuing operations for 2012 was $7,308,000, or ($0.63) per basic and diluted common share, compared to a loss from continuing operations for 2011 of $6,325,000, or ($0.53) per basic and diluted common share. The additional losses from continuing operations of $983,000 for 2012 were primarily due to $1,514,000 of increased operating expenses partially offset by $546,000 of additional gross profit from both slightly increased sales and improved gross profit rates. During 2011, the Company recorded a gain from discontinued operations of $242,000, or $0.02 per basic and diluted common share, net of income tax expenses of $125,000.

Overall, net worldwide sales for 2012 increased $218,000, or 1%, to $22,669,000 from $22,451,000 in 2011. The following table provides comparative results of net sales by product and geographic category:

($000's)
                                         Year Ended              Year Ended             Increase /
                                      December 31, 2012       December 31, 2011         (Decrease)

Tissue Oximetry Monitoring           $             7,776     $             6,327     $           1,449
Traditional Vital Signs Monitoring                14,893                  16,124                (1,231 )
                                     $            22,669     $            22,451     $             218

Domestic Sales                       $            17,511     $            16,810     $             701
International Sales                                5,158                   5,641                  (483 )
                                     $            22,669     $            22,451     $             218

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Worldwide tissue oximetry product sales for 2012 of $7,776,000 increased $1,449,000 or 23% over the $6,327,000 reported for 2011 led by increased sensor sales.

Traditional vital signs monitoring sales decreased $1,231,000 or 8% to $14,893,000 for 2012 from $16,124,000 for 2011. The decrease was primarily associated with reductions in sales of the Company's vital signs monitors to the U.S. Government and to veterinary customers and lower sales of neonatal intensive care supplies.

Total domestic sales increased $701,000 or 4% to $17,511,000 or 77% of total revenues for 2012 from $16,810,000 for 2011. Tissue oximetry sales increased 43% and were partially offset by decreases in vital signs monitoring product sales and neonatal intensive care supplies.

International sales declined $483,000 or 9% to $5,158,000 or 23% of total revenues for 2012 from $5,641,000 or 25% of total revenues for 2011. Increases in sales of vital signs monitors and accessories were offset by lower sales of tissue oximetry products and OEM technology products.

The following table provides information with respect to tissue oximetry revenues:

($000's)
                                    Year Ended              Year Ended             Increase /
                                 December 31, 2012       December 31, 2011         (Decrease)

Sensor Sales                    $             6,567     $             4,786     $           1,781
Monitor and Accessories Sales                 1,209                   1,541                  (332 )
                                $             7,776     $             6,327     $           1,449

Domestic Sales                  $             6,063     $             4,234     $           1,829
International Sales                           1,713                   2,093                  (380 )
                                $             7,776     $             6,327     $           1,449

Worldwide tissue oximetry sensor sales for 2012 were $6,567,000, an increase of $1,781,000 or 37% over 2011 sales of $4,786,000. Worldwide sales of monitors and accessories for 2012 decreased $332,000 or 22% to $1,209,000 from 2011 sales of $1,541,000. As of December 31, 2012, the Company's worldwide installed base of oximetry monitors was 741 units, an increase of 35% above the installed base of 549 as of December 31, 2011.

Cost of sales as a percentage of net sales was 60% for 2012 and 62% for 2011. Lower manufacturing variances, improved factory productivity, and reduced warranty costs accounted for the improvement in cost of sales as a percentage of sales. Cost of sales for 2011 included warranty expense of $259,000 related to the Company's OEM technology products.

R&D expenses increased $495,000, or 14%, to $4,020,000 for 2012 from $3,525,000 for 2011. The increase resulted primarily from additional employee costs due to personnel additions and increased clinical evaluations offset by reduced engineering project costs.

R&D expenses are reported net of reimbursements received from the National Institutes of Health ("NIH") pertaining to the Company's development of its Near-Infrared Spectroscopy ("NIRS") technology. Amounts reimbursed from the NIH, including accruals, for 2012 and 2011 were $296,000 and $367,000, respectively. The Company's most recent grant of $2,800,000 awarded during September 2007 has been fully utilized and no further reimbursements remained under the award as of December 31, 2012. In addition, the Company received $148,000 in state tax credits during 2012 which it also credited to R&D expenses. R&D expenses are expected to increase for 2013 primarily due to various planned product validation costs and expanded clinical research expenditures.

Selling, general, and administrative ("S,G&A") expenses increased $1,019,000, or 9%, to $12,529,000 for 2012 from $11,510,000 for 2011. The increases in S,G&A expenses were primarily related to field sales expenses and legal expenses which were partially offset by reduced meeting and convention costs. S, G&A expenses are expected to increase during 2013 primarily from increases in field-based sales spending, additional marketing promotional expenditures, and medical device excise taxes associated with the Affordable Care Act of 2010.

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Interest expense for 2012 reflects the Company's term debt agreement with its bank lender executed July 31, 2012 as described below.

The income tax benefit for continuing operations for 2012 and 2011 was $211,000 and $125,000, respectively. The income tax benefit for 2012 pertains to uncertain state income tax positions which have been derecognized as a result of net operating losses incurred over the past six years, the availability of net operating loss carry backs in certain jurisdictions and administrative practices in jurisdictions which gave rise to the original accrual. The income tax benefit for 2011 was offset by related income tax expense for discontinued operations. The Company does not expect to record taxable income during its 2013 fiscal year. Income tax benefits that may be generated during 2013 would be offset by a deferred income tax asset valuation allowance. Management established the valuation allowance as of December 31, 2009, as a result of then recent cumulative pre-tax losses and its estimates of future taxable income. Management has continued to perform the required analysis regarding the realization of our deferred income tax assets concluding that a full valuation allowance is warranted. As of December 31, 2012, the deferred income tax asset valuation allowance balance was $6,061,000.

Financial Condition, Liquidity, and Capital Resources

On June 8, 2011, the Company entered into an investment agreement (the "Agreement") pursuant to which the Company issued on June 9, 2011, (i) 95,500 shares of a newly created series of preferred stock, designated "Series A Convertible Preferred Stock," par value $0.001 per share (the "Series A Preferred Stock"), which are convertible into authorized but unissued shares of common stock, par value $0.004 per share, of the Company and (ii) 54,500 shares of a newly created series of preferred stock, designated "Series A Exchangeable Preferred Stock," par value $0.001 per share (the "Series A Exchangeable Preferred Stock") which are now convertible, following stockholder approval, into authorized but unissued shares of common stock, par value $0.004 per share, of the Company. The Company received an aggregate cash purchase price of $15.0 million representing a per-share purchase price of $100 for each of the Series A Preferred Stock and the Series A Exchangeable Preferred Stock. The Company utilized a placement agent to assist in the transaction which was paid a fee of $900,000 plus certain expenses. The Company received net proceeds, after transaction costs and expenses, of $13,825,000.

The Company's cash, cash equivalents, and short-term investments were $10,496,000 at December 31, 2012, compared to $13,878,000 at December 31, 2011. Working capital decreased $4,587,000 to $12,619,000 at December 31, 2012, from $17,206,000 at December 31, 2011.

The Company's continuing operations used $5,110,000 in cash for 2012. Losses from continuing operations of $7,308,000 were affected by $1,961,000 of depreciation, amortization, and stock compensation expenses and $237,000 of changes in various working capital accounts. During 2011, $3,604,000 of net cash was used by operating activities of continuing operations. Losses from continuing operations of $6,325,000 were affected by $1,758,000 of depreciation, amortization, and stock compensation expenses and $963,000 of working capital items primarily related to reductions in inventory.

Net cash used by investing activities of continuing operations was $437,000 for 2012 compared to cash used of $3,752,000 for 2011. The Company incurred $1,565,000 of capital expenditures during 2012 compared to $1,112,000 for 2011. For both periods, the expenditures were primarily related to placements of FORE-SIGHT oximeter monitors at customer locations. During 2011, the Company invested $2,491,000 in short-term certificates of deposit with varying maturities. In 2012, $1,240,000 related to these certificates of deposit had matured and were transferred to operating cash accounts. During 2013, the Company expects to further increase its capital expenditures for continuing equipment placements at customer sites and for its operating needs to support new product introductions.

The Company also expended $111,000 and $150,000 during 2012 and 2011, respectively, to purchase intangible assets which were primarily related to patent costs and product translations.

Net cash provided by financing activities of continuing operations was $3,405,000 for 2012 compared to cash provided of $13,884,000 for 2011.

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On July 31, 2012, the Company entered into a Loan and Security Agreement (the "Loan Agreement") with East West Bank (the "Bank"). Pursuant to the Loan Agreement, the Bank provided the Company with a secured $3,500,000 term loan (the "Term Loan") which bears interest at 5.5% and is scheduled to mature on July 31, 2015. The Term Loan contains a 12-month interest-only feature with principal payable in 24 equal installments of approximately $154,000 commencing in August 2013.

The Loan Agreement also provides for a maximum of $2,500,000 revolving line-of-credit which expires on January 31, 2014 (the "Revolver"). Under the Loan Agreement, advances under the Revolver bear interest at a floating rate equal to 2.00% above the Bank's prime rate, with a 3.25% floor on the prime rate, representing an effective rate of 5.25%, as of December 31, 2012. Interest on the loans is payable monthly. Under the terms of the Loan Agreement, the Company is permitted to borrow against eligible accounts receivable as defined under the Loan Agreement according to pre-established criteria. The amount available for borrowing under the Revolver as of December 31, 2012, was $1,177,000. There were no borrowings under the Revolver as of December 31, 2012.

The Loan Agreement contains customary negative covenants limiting the ability of the Company and its subsidiaries, among other things, to grant liens on the pledged collateral, pay cash dividends, make certain investments and acquisitions and dispose of assets outside the ordinary course of business. The Loan Agreement also contains financial covenants, measured quarterly, providing minimum levels of the Company's tangible net worth and non-financial covenants with respect to the timing of certain new product approvals. As of December 31, 2012, the Company was in compliance with the Loan Agreement covenants.

Net cash provided by financing activities of continuing operations for 2011 included $13,825,000 from the private placement of shares of our Series A Convertible Preferred Stock and Series A Exchangeable Preferred Stock.

The Company currently leases three facilities and certain equipment under non-cancellable operating leases. The following table sets forth a summary of the Company's cash commitments under contractual obligations as of December 31, 2012.

  Contractual                       Less than                                              More Than
  Obligations         Total          One Year        2 - 3 Years       4 - 5 Years        Five Years

Operating leases   $ 1,695,000     $    485,000     $     761,000     $     449,000     $             -

The Company's 2013 business plans call for increased operating expenditures primarily to develop and market our FORE-SIGHTŪ technology and our other product lines. Our ordinary short-term capital needs are expected to be met from our current cash on hand and amounts available under our Loan Agreement with East West Bank. However, we may, from time to time, seek additional funding through a combination of equity and debt financings or from other sources.

Cash flows may be impacted by a number of factors, including changing market conditions, market acceptance of the FORE-SIGHT system, and the loss of one or more key customers.

The Company's results of operations were not affected by inflation during 2012.

Off-Balance Sheet Arrangements

The Company has no off-balance sheet arrangements other than operating leases for office and warehouse space.

Critical Accounting Policies

The Company's financial statements have been prepared in accordance with generally accepted accounting principles in the United States. In preparing the financial statements, the Company is required to make estimated judgments. Such judgments are based upon historical experience and certain assumptions that are believed to be reasonable in the particular circumstances. Those judgments affect both balance sheet and income statement accounts and disclosures. The Company evaluates its assumptions on an ongoing basis by comparing actual results with its estimates. Actual results may differ from the original estimates. The following accounting policies are those that the Company believes to be most critical to the preparation of its financial statements.

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Inventory Valuation - The Company's inventories are stated at the lower of cost or market. The Company provides allowances on inventories for any material that has become obsolete or may become unsalable based on estimates of future demand and the sale price in the market. Judgments with respect to salability and usage of inventories, estimated market value, and recoverability upon sale are complex and subjective. Such assumptions are reviewed periodically and adjustments are made, as necessary, to reflect changed conditions. There were no significant write-offs for any period presented with the exception of the discontinued infant sleep apnea product line.

Deferred Income Tax Assets - The Company has recorded deferred income tax assets for the estimated benefit of future tax deductions on inventories, property and equipment and other accruals, as well as net operating loss carry forwards and tax credits. Based on recent cumulative pre-tax losses and the Company's estimates of future taxable income, management has established a deferred tax asset valuation allowance.

Accrued Warranty Costs - The Company warranties its products for up to three years and records the estimated cost of such product warranties at the time the sale is recorded. Estimated warranty costs are based upon actual past experience of product returns and the related estimated cost of labor and material to make the necessary repairs. Warranty costs have not been historically material to operating results. However, if actual future product return rates or the actual costs of material and labor differ from the estimates, adjustments to the accrued warranty liability would be made.

Stock-based Compensation - The Company records the fair value of stock-based compensation awards as expenses in its consolidated statement of operations. In order to determine the fair value of stock options on the date of grant, we apply the Black-Scholes option-pricing model. Inherent in this model are assumptions related to expected dividend yield, risk-free interest rate, expected stock-price volatility, expected term, and forfeiture rate. Restricted stock awards are generally valued upon the closing price of the common stock on the date of the grant. Amortization of stock-based awards takes place over the vesting period associated with the award.

Revenue and Accounts Receivable Recognition - Revenue from sales and accounts receivable are recognized when evidence of an arrangement exists, delivery has occurred based upon shipping terms, the selling price is fixed and determinable, and collectability is reasonably assured. Terms of sale for most domestic sales are FOB origin and for most international sales are EX-Works reflecting that ownership and risk of loss are assumed by the buyer at the shipping point. In addition, the Company has certain agreements with its customers to ship FOB destination reflecting that ownership and risk of loss are assumed by the buyer upon delivery. While the Company accepts returns of products from its customers from time to time for various reasons including defective goods, order entry, shipping or other errors, the Company's business practices do not include providing right of return at the time of sale. Historically, such returns have not been significant. The Company has entered into agreements with several customers to provide them with price rebates based upon their level of purchases. Rebates are accrued by the Company as a reduction in net sales as they are earned by customers. Payment terms range from prepayment to net sixty days depending upon certain factors including customer credit worthiness, geographic location and customer type (i.e., end-user, distributor, government or private entity) and also includes irrevocable letters of credit for certain international shipments. Price discounts that may be taken by customers under contractual arrangements for payment of invoices within specified periods are recorded as reductions to net sales. Further, the Company accrues expected payment discounts based upon specific customer accounts receivable balances. The Company does not incur post-shipment obligations with the exception of product warranties which are generally fulfilled from the Company's corporate facilities and which costs are not material relative to the sale of the product. Accounts receivable are charged to the allowance for doubtful accounts when deemed uncollectible.

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