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HRT > SEC Filings for HRT > Form 10-K on 31-May-2013All Recent SEC Filings

Show all filings for ARRHYTHMIA RESEARCH TECHNOLOGY INC /DE/ | Request a Trial to NEW EDGAR Online Pro

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


31-May-2013

Annual Report


Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussions of the Company's results of operations and financial condition should be read in conjunction with the consolidated financial statements and notes pertaining to them that appear elsewhere in this Form 10-K. 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 expectations are based on reasonable assumptions, management can give no assurance that the expectations will materialize. Many factors could cause actual results to differ materially from our forward looking statements. Several of these factors include, in addition to those contained in "Risk Factors":
our ability to retain customers who represent significant proportions of revenue;

our ability to maintain the pricing model, and/or decrease the cost of sales;

our ability to increase sales of higher margin products and services;

our ability to manage our level of debt which makes us sensitive to the effects of economic downturns; our level of debt and provisions our debt agreements which could limit our ability to react to changes in the economy or our industry;

our ability to comply with the covenants contained in our credit facility. This includes as a result of events beyond our control, which could result in an event of default, which could materially and adversely affect our operating results and our financial condition;

volatility in commodity and energy prices and our ability to offset higher costs with price increases;

continued availability of supplies or materials used in manufacturing at competitive prices;

variability of customer delivery requirements;

a stable interest rate market and/or a stable currency rate environment in the world and specifically the countries where the Company is doing or plans to do business;

the amount and timing of investments in capital equipment, sales and marketing, engineering and information technology resources;

our ability to offset higher costs with price increases;

our ability to attract and retain employees with the skills to meet the technically complex demands of US manufacturing;

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;

our ability to execute plans and motivate personnel in the execution of those plans;

our ability to protect and retain trade secrets related to our manufacturing processes;

adverse claims relating to the Company's intellectual property;

adoption of new, or changes in, accounting principles; and passage of new, or changes in regulations;

other risks referenced from time to time elsewhere in this report and in the Company's filings with the SEC;

adverse regulatory developments specifically healthcare policy changes, environmental and other regulatory changes;

the costs inherent with complying with statutes and regulations applicable to public reporting companies, such as the Sarbanes-Oxley Act of 2002 and the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010;

our ability to efficiently integrate future acquisitions and other new lines of business that the Company may enter in the future, if any;

our ability to maintain compliance with the NYSE MKT requirements for continued listing of our common stock;

our securities may be delisted from the NYSE MKT which could limit investors' ability to effect transactions in the Company's securities and subject the stock to additional trading restrictions; and

general economic conditions.

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.
Results of Operations
The Company was unable to file its Annual Report on Form 10-K for the year ended December 31, 2012 by the required filing date of April 1, 2013 because the Company determined that it was necessary to reevaluate the accounting for revenues recognized under its Tooling arrangements. As a result of its reevaluation, the Company identified prior period errors relating to the accounting for certain Tooling transactions.
The Company concluded that these errors were not material individually or in the aggregate to any of the prior reporting periods, and therefore, amendments of previously filed reports were not required. As such, the prior period financial statements included in this filing have been revised to reflect the correction of these errors.


ART and its subsidiary, Micron (collectively the "Company"), is a diversified manufacturer specializing in plastic molding, precision metal and plastics machining and precious metal coating. ART is also engaged in development and licensing signal-averaged electrocardiographic (SAECG) software, through its Predictor brand. RMDDxUSA Corporation and RMDDx Corporation collectively called "WirelessDx" discontinued operations in the third quarter of 2012.
The following table sets forth for the periods indicated, the percentages of the net sales represented by certain items reflected in the Company's statements of operations.

                                       Years ended December 31,
                                         2012        2011 Revised
Net sales                               100.0    %       100.0   %
Cost of sales                            86.5             78.1
Gross profit                             13.5    %        21.9   %
Goodwill impairment                       7.2              0.3
Selling and marketing                     4.4              3.9
General and administrative               15.0             11.2
Research and development                  2.5              1.7
Other expense                             0.1              0.1
(Loss) income before income tax
provision and discontinued
operations                              (15.7 )            4.7
Income tax (benefit) provision           (4.2 )            1.6
(Loss) income from continued
operations                              (11.5 )            3.1
Loss from discontinued operations       (18.2 )           (8.5 )
Net loss                                (29.7 )  %        (5.4 ) %

Net Sales
The Company's consolidated net sales for 2012 were $20,642,570, a decrease of $3,663,527 or 15.1%, when compared to the total net sales of $24,306,097 in 2011. Decreases in silver prices resulted in $2,323,777, or 63.4% of this decrease. The remainder was due primarily to a combination of lower order volume and price reductions.
Cost of Sales
The Company's consolidated cost of sales was $17,848,591 (86.5% of net sales) in 2012 compared to $18,986,130 (78.1% of net sales) in 2011; a decrease of $1,137,539 or 6.0%. This variance was largely due to a decrease of $1,047,081 related to both the cost and purchase volume of silver. The decrease was also due, in part, to lower materials costs of $101,170 and lower overhead expenses of $139,748 due to the decrease in revenues. These variances were partially offset by an increase in payroll and benefits for direct and indirect labor of $324,390 as well as an increase in scrapped materials and inventory obsolescence reserves of $245,739.
Selling and Marketing
The Company's consolidated selling and marketing expense decreased to $921,045 (4.4% of net sales) in 2012 from $950,934 (3.9% of net sales) in 2011; a decrease of $29,889 or 3.1%. In 2012, expense decreases related to a temporary redirection of staff to the discontinued operations and lower attendance at trade shows versus the prior year.
General and Administrative Expenses
The Company's consolidated general and administrative expense increased to $3,102,643 (15.0% of net sales) in 2012 as compared to $2,732,426 (11.2% of net sales) in 2011; an increase of $370,217 or 13.5%. This increase was due in part to $210,739 in severance expense for the former Chief Executive Officer. This increase was also due in part to $117,616 in additional accounting and tax related professional fees, in part as a result of the third quarter goodwill impairment as well as cost incurred to remediate internal control weaknesses identified in 2011. Additionally, there were increases in professional fees of $190,637, write-offs of patents and trademarks in process of $33,192 and miscellaneous other expenses of $29,001. Research and Development
The Company's consolidated research and development costs increased to $510,463 (2.5% of net sales) in 2012 from $407,960 (1.7% of net sales) in 2011; an increase of $102,503, or 25%. The increase is related to costs associated with developing improved processes in manufacturing, and increased expense related to patent work and enhancements to the Predictor software.


Other (Expense) Income
Other expense was $33,200 in 2012 compared to other income of $13,655 in 2011, a decrease of $46,855. Interest expense was $23,881 in 2012 compared to $226 in 2011. The Company does not incur an unused borrowing base fee under the current credit facility. Other income included bank interest of $248 and $6,853, in 2012 and 2011, respectively.
Income Taxes
The Company's combined federal and state effective income tax rate from continuing operations was 27.2% and 33.9% in 2012 and 2011, respectively. The effective rate in 2012 includes a permanent tax adjustment for the book impairment of goodwill attributed to continuing operations. Excluding this one-time impairment charge, the Company's 2012 effective tax rate would have been 39.8%.
The effective rate in 2012 included a valuation allowance of $470,900 as compared to $351,000 in 2011 against deferred income taxes related to discontinued operations. The 2011 effective tax rate also included tax return to provision adjustments of $146,000 from 2010 that were recorded against the 2011 provision.
The Company also reported no federal benefit for a research and development tax credit, as this provision was not extended until after the balance sheet date. Loss from Discontinued Operations
At a special meeting of the Board of Directors (the "Board") held on July 13, 2012, the Board authorized the Company's management to consider strategic alternatives, on the most favorable terms it can obtain, for all or some portion of the assets of the WirelessDx subsidiaries. On September 4, 2012, the Company's Board of Directors on the recommendation of management authorized the discontinuance of operations and disposition of the assets of WirelessDx. The expenses and charges related to the termination of WirelessDx operations and its liquidation were $2.4 million. These expenses and charges were comprised of the following major components: (i) $1.0 million related to the impairment of fixed assets, net of liquidation proceeds; (ii) $0.1 million related to the early termination of multiple lease contracts; (iii) $1.0 million for a contingent liability of an unmet performance obligation, for which the liability is carried on the balance sheet of continuing operations as the liability is guaranteed by ART; and (iv) $0.3 million in employee related and other one-time expenses associated with the orderly shutdown of the monitoring operation. The Company sold the majority of the assets prior to the end of 2012. Loss from discontinued operations was $3,760,827 for the period ended December 31, 2012 compared to $2,075,224 for the period ended December 31, 2011. Goodwill
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.
The Company's annual goodwill impairment test is conducted at December 31 of each calendar year and interim evaluations are performed when the Company determines that a triggering event has occurred that would more likely than not reduce the fair value of its goodwill below it carrying value. During the third quarter of 2012, due to a decline in the market price of the Company's stock, the market capitalization of the Company was below the carrying value. Management considered this a triggering event and therefore performed an interim impairment test.
Accordingly, the Company performed an impairment analysis as of September 30, 2012. Based on the Step 1 analysis, management determined that the fair value of the reporting unit was below the carrying value as of September 30, 2012. The Company's Step 1 analysis was performed using the income approach in which the Company utilized a discounted cash flow analysis to determine the fair value of its reporting unit. The income approach requires management to estimate a number of factors which are considered Level 3 inputs, including projected future operating results, economic projections, anticipated future cash flows and discount rates. As part of its valuation to determine the total impairment charge, the Company is also required to perform a Step 2 analysis which includes estimating the fair value of significant tangible and intangible long-lived assets.
As a result, the Company preliminarily determined that the full value of its goodwill was impaired. The Company recorded, in the third quarter of 2012 an estimated preliminary impairment charge of $1,479,727. Step 2 of the impairment test was completed in the fourth quarter of 2012 and it was determined that the full value of its goodwill was in fact impaired. The goodwill impairment charge for the year ended December 31, 2012 was $1,479,727.
At December 31, 2011, the market price of the Company's stock was trading lower than its book value for a prolonged period. The Company was required to acknowledge this as a possible triggering event and that an impairment may exist. In addition, the Company had reorganized its reporting unit structure to combine the three reporting units (Micron Products, New


England Molders, and Leominster Tool) with goodwill into one reporting unit. The combined reporting unit better reflects the synergies between these components and aligns the segment with how management reviews and operates the business. An analysis of goodwill of the three reporting units prior to combining was performed to determine fair value using income and market approaches. The income approach is based on a discounted cash methodology that includes assumptions of, among other things, forecast income, cash flow, growth rates, and long-term discount rates, all of which require significant judgment. The market approach utilizes the Company's market data as well as market data from publicly traded companies that are similar to the Company. There are inherent uncertainties related to these factors and the judgment applied in the analysis.
Management determined impairment was required for the Leominster Tool portion of the goodwill equal to $85,239. The Company changed the goodwill annual test date to December 31 aligning the test with the year end audit. As required, the Company's independent registered public accounting firm issued a preferability letter on the matter. The goodwill impairment charge for the year ended December 31, 2011 was $85,239.
Long-Lived Assets
In accordance with ASC 360, "Long Lived Assets," management assesses the impairment of long-lived assets and intangible assets with finite lives whenever events or changes in circumstances indicate that the carrying value may not be fully recoverable. In the third quarter of 2012, the Company experienced a triggering event as a result of the goodwill impairment as described above. When the Company's management determines that the carrying value of such assets may not be recoverable, management determines whether impairment exists based on projected undiscounted cash flows. In 2012, $33,192 of certain patents related to Predictor UK and Predictor Europe approval were deemed to be impaired, while in 2011, certain groups of long-lived assets used in production and research and development were impaired for $153,079.
Loss Per Share
The basic and diluted loss per share is $2.22 in 2012 as compared to $0.47 in 2011, an increase in loss per share of $1.75 per share. The loss per share reflects operational losses during the scale up of WirelessDx, the impairment of equipment held for sale and goodwill, and the increase in the tax valuation allowance.
Off-Balance Sheet Arrangements
The Company entered into a sale lease-back transaction for certain equipment purchased during 2009 totaling $677,810. A five year operating lease obligation for the equipment began December 31, 2009 with the first payment due February 1, 2010. The transaction includes an additional $320,817 of lease line capacity. The operating lease requires payments totaling $207,591 in 2013 and 2014 and $45,591 in 2015.
Liquidity and Capital Resources
Working capital was $1,141,825 as of December 31, 2012 as compared to $6,120,313 as of the same date in 2011. Operating activities of continuing operations produced positive cash flows of $687,842 in 2012, as compared to $2,632,996 in 2011.
Cash balances were $477,708 and $1,255,251 at December 31, 2012, and 2011, respectively. Substantially all of these funds are maintained in bank deposit accounts.
Inventories decreased to $2,415,104 at the end of 2012 as compared to $3,267,482 as of the same date in 2011, a decrease of $852,378. This decrease was due in part to an adjustment of $341,458 in overhead absorption, a decrease of $336,657 in the cost of silver, and an increase of $143,613 in inventory reserves for slow moving or obsolescence inventory.
Capital equipment expenditures were $1,294,802 in 2012 as compared to $2,830,240 in 2011. In 2012, capital expenditures for machinery and equipment were $926,250, largely due to investments in our precision machining capabilities. 2012 also included $435,609 of investments in molding equipment. In 2011, the Company installed a 200kW solar panel array and completed an energy optimization program for a capital cost of approximately $1,384,000. This program is expected to reduce the Company's electrical costs. In 2012, under a Federal program, the Company received a $318,627 grant for the solar installation. The majority of the Company's remaining $170,686 of capital expenditures during 2012 were spent on the addition and replacement of production equipment.
On, March 29, 2013, the Company entered into a multi-year credit facility with a Massachusetts based bank. The new credit facility includes a revolving line of credit ("revolver") of up to $4.0 million, a commercial term loan of $1.5 million and an equipment line of credit of $1.0 million. The new credit facility is secured by certain tangible and intangible property including equipment and fixtures, inventory, accounts receivable, cash and deposit accounts, trademarks, and patents.
The $4.0 million revolver, which provides for borrowings up to 80% of net eligible receivables and 50% of net eligible raw materials inventory, replaced the previous $3.0 million demand line of credit which was scheduled to expire April 30, 2013. The letter of credit from the discontinued operations was secured with cash from this line of credit. The revolver has a maturity date of June 30, 2015. Advances bear interest at the prime rate published by the Wall Street Journal (the "Prime Rate") plus one quarter of one percent with interest payable monthly.
The $1.5 million commercial term loan was used to refinance existing Equipment notes and to fund other current liabilities of continuing operations. The term loan has a five year term with a maturity date of March 29, 2018. The term loan provides for


payments of principal and interest in sixty monthly installments with a maturity date of March 29, 2018 and a prepayment fee of between 3% and 1%. The unpaid principal balance bears interest at 4.25% per annum.
The equipment line of credit of $1.0 million is for the purchase of capital equipment. Advances on the equipment line shall not exceed 80% of the invoice amount of the equipment being purchased. The term of the equipment line of credit is six years, maturing on March 29, 2019, inclusive of a one year maximum draw period. The outstanding principal balance bears interest at the Prime Rate plus one quarter of one percent (the "Base Rate") until the earlier of March 29, 2014 or the date all advances equal $1 million ("the Conversion Date"). Thereafter the rate will be the greater of the Base Rate plus 3% or 4.25%. Interest is payable monthly until the Conversion date and thereafter principal and interest are payable until the maturity date.
In 2012, a $3,000,000 demand line of credit was available, increased from $2,000,000 in 2011. The agreement provided for borrowings up to 80% of eligible accounts receivable plus 50% of finished goods inventories. This facility did not carry an annual borrowing base charge. There was $800,000 of outstanding borrowings on our line of credit as of December 31, 2012 versus no outstanding borrowings at December 31, 2011. The agreement contained covenants that applied upon drawing on the line 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. In 2012, the line of credit was amended to provide that borrowings were secured by accounts receivable, inventory, cash and deposit accounts. The line of credit had an annual renewal date in April 2013 and was secured with cash from the new line of credit.
Also, secured by this credit line, the Company had a $1,000,000 letter of credit for an unmet performance obligation related to an economic incentive package related to the discontinued operations. The liability is carried on the balance sheet of continuing operations as the liability has been guaranteed by ART. The outcome of this liability will be determined on or before June 2014. This lease line was amended in 2012 to accommodate a credit limit increase to $2,000,000, and enable the flexibility of either an operating or capital lease. Production equipment for approximately $523,269 was acquired by Micron using this lease line in the first quarter of 2012. In the second quarter of 2012 an additional $888,269 of equipment was acquired to support the capital need of WirelessDx. As of year ended December 31, 2012, this amount was recorded in continuing operations as it was cross collateralized by ART. These leases were paid off and closed on April 1, 2013 with the term loan from the new bank facility.
On January 25, 2012, the Board of Directors declared a quarterly cash dividend of $0.03 per share. The dividend of $84,119 was paid March 15, 2012. On each of January 25, 2011 and July 15, 2011 the Board of Directors declared dividends of $0.06 per share payable on March 1 and August 12, 2011, respectively, for a total of $0.12 per share or $344,659 for the year.
The Company expects that its current and anticipated financial resources, including the new credit facility, are adequate to maintain current and planned operations through December 31, 2013. However, if the Company is not successful in generating sufficient revenues, it may not be able to fund its debt obligations or fund operations beyond December 31, 2013. The Company expects to continue to expand its product offerings 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.
Summary of Changes in Cash Position
As of December 31, 2012, the Company had cash of continuing operations of $477,708, a decrease of $777,543 from December 31, 2011. Cash used in operating activities totaled $1,108,301. Cash provided by operating activities of continuing operations was $687,842, while cash used in operating activities of discontinued operations was $1,796,143. Total cash used in investing activities was $1,238,782 comprised of cash used in continuing operations of $772,552 and cash used in discontinued operations of $466,230. Total cash provided by financing activities was $1,497,450, all from continuing operations. As of December 31, 2011, the Company had cash of continuing operations of $1,255,251, a decrease of $2,604,231 from December 31, 2010. Cash used in continuing operations was $617,359 and cash used in discontinued operations was $1,986,872. Total cash provided by operating activities totaled $926,488. Cash provided by operating activities of continuing operations was $2,632,996, offset in part by cash used in operating activities of discontinued operations of $1,706,508. Total cash used in investing activities was $3,186,060 comprised of cash used in investing activities of continuing operations of $2,905,696 and cash used in investing activities of discontinued operations of $280,364. Total cash used in financing activities was $344,659, all from continuing operations. Operating Cash Flows
Cash used in operating activities was $1,108,301 consisting of cash provided by continuing operations of $687,842 and cash used in discontinued operations of $1,796,143. The cash provided by operating activities from continuing operations was due primarily to working capital of $2,649,858 and add-backs for the net loss from discontinued operations of $3,760,827, goodwill impairment of $1,479,727, depreciation and amortization of $1,419,226. The favorable $2,649,858 from working capital includes the recording of a $1.0 million performance guarantee, in the form of a letter of credit, associated with the discontinued operations. This liability is being carried on the balance sheet of continuing operations, as the letter of credit is guaranteed by ART. This was partially offset by cash used in operating activities from continuing operations due primarily to the net loss of $6,137,934 and the


change in deferred taxes of $2,684,000. The cash provided by working capital is due in part to reduction of inventory levels of $852,378. Investing Cash Flows
Cash used in investing activities was $1,238,782 consisting of cash used in continuing operations of $772,552 and cash used in discontinued operations of $466,230. Cash used in investing activities from continuing operations was primarily due to capital expenditures of $1,294,802. Capital expenditures for machinery and equipment were $926,250, largely due to investments in our . . .

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