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CASM > SEC Filings for CASM > Form 10-K on 19-Mar-2014All Recent SEC Filings

Show all filings for CAS MEDICAL SYSTEMS INC

Form 10-K for CAS MEDICAL SYSTEMS INC


19-Mar-2014

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.

Overview

This past year was transformational for CASMED. After significant investment over the prior three years, the Company reached major milestones by introducing new products in three major product categories: tissue oximetry, vital signs monitoring, and non-invasive blood pressure monitoring. These new state-of-the-art products, introduced into improved distribution channels and supported by renewed marketing efforts, should be the final and key steps to enable CASMED to emerge from its turn-around and transform itself into a growing company. We believe this line-up of new products should enable revenue growth, help improve margins, create operational leverage, and permit the Company to eventually reach profitability.

During the year ended December 31, 2013, specific accomplishments included:

? The Company launched four new products during 2013 - the next-generation FORE-SIGHT ELITE™ cerebral monitor and sensors; the next generation 740 SELECT™ and PPM3 vital signs monitors; and its new MAX IQ non-invasive blood pressure technology.

? The total number of FORE-SIGHT monitors shipped during the year was 194, increasing the cumulative total, as of December 31, 2013, to 935, an increase of 26% from December 31, 2012.

? Total FORE-SIGHT revenues increased 16%, led by a 23% growth in U.S.
FORE-SIGHT sales.

? In May 2013, the Company amended its term loan with East West Bank, increasing the principal amount to $5.0 million and extending the maturity date to July 2016.The Company's revolving line-of-credit was reduced to $2.0 million. As of December 31, 2013, the revolver remained undrawn.

? During July 2013, the Company completed an underwritten public offering for the purchase of 5.2 million shares of its common stock. Net proceeds to the Company were $5.8 million.

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.

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Year Ended December 31, 2013 Compared to Year Ended December 31, 2012

The Company recorded a net loss applicable to common stockholders of $11,566,000 for 2013 or ($0.73) per basic and diluted common share compared to a net loss applicable to common stockholders of $8,432,000, or ($0.63) per basic and diluted common share, for 2012. The net loss for 2013 was $10,362,000, or ($0.66) per basic and diluted common share, compared to a net loss for 2012 of $7,308,000, or ($0.55) per basic and diluted common share. The loss from operations of $10,453,000 increased $3,008,000 for 2013 compared to $7,445,000 for 2012 due primarily to lower sales levels, reduced gross profit rates, and increased operating expenses.

Overall, net worldwide sales for 2013 decreased $753,000 or 3% to $21,916,000 from $22,669,000 in 2012. The following table provides comparative results of net sales by product and geographic category:

($000's)
                             Year Ended              Year Ended            Increase /              %
                          December 31, 2013       December 31, 2012        (Decrease)           Change

Tissue Oximetry
Monitoring               $             9,051     $             7,776     $         1,275              16%
Traditional Vital
Signs Monitoring                      12,865                  14,893              (2,028 )           (14%)
                         $            21,916     $            22,669     $          (753 )            (3%)

Domestic Sales           $            17,114     $            17,511     $          (397 )            (2%)
International Sales                    4,802                   5,158                (356 )            (7%)
                         $            21,916     $            22,669     $          (753 )            (3%)

Worldwide tissue oximetry product sales for 2013 of $9,051,000 increased $1,275,000 or 16% over the $7,776,000 reported for 2012 led by increased sensor sales.

Traditional vital signs monitoring sales decreased $2,028,000 or 14% to $12,865,000 for 2013 from $14,893,000 for 2012. The decrease was primarily associated with lower shipments of the Company's vital signs monitors to the U.S. Government and pricing adjustments pertaining to OEM technology product sales. The 2013 decline in OEM sales was also partially due to weakness in the sales of several of our OEM partners monitoring products.

Total domestic sales decreased $397,000 or 2% to $17,114,000 or 78% of total revenues for 2013 from $17,511,000 for 2012. Domestic tissue oximetry sales increased 17% led by a 23% increase in disposable sensor sales. Tissue oximetry sales were more than offset by decreases in vital signs monitoring product sales and OEM technology product sales.

International sales declined $356,000 or 7% to $4,802,000 or 22% of total revenues for 2013 from $5,158,000 or 23% of total revenues for 2012. Lower sales of vital signs monitoring products accounted for the reduction in international sales.

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

($000's)
                             Year Ended              Year Ended            Increase /              %
                          December 31, 2013       December 31, 2012        (Decrease)            Change

Sensor Sales             $             7,903     $             6,567     $         1,336               20%
Monitor and
Accessories Sales                      1,148                   1,209                 (61 )             (5%)
                         $             9,051     $             7,776     $         1,275               16%

Domestic Sales           $             7,119     $             6,063     $         1,056               17%
International Sales                    1,932                   1,713                 219               13%
                         $             9,051     $             7,776     $         1,275               16%

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Worldwide tissue oximetry sensor sales for 2013 were $7,903,000, an increase of $1,336,000 or 20% over 2012 sales of $6,567,000. Worldwide sales of monitors and accessories for 2012 decreased $61,000 or 5% to $1,148,000 from 2012 sales of $1,209,000. As of December 31, 2013, the Company's worldwide cumulative shipments of oximetry monitors were 935 units, an increase of 26% compared to December 31, 2012.

Gross profit as a percentage of net sales was 34% for 2013 and 40% for 2012. While a multitude of factors unfavorably impacted the gross profit percentage for 2013, the decrease was largely related to the Company's transition from its first-generation FORE-SIGHT oximetry monitoring technology to its next-generation FORE-SIGHT ELITE technology. Asset impairment charges, accelerated depreciation, inventory obsolescence charges, and purchase order cancellations, all pertaining to the first-generation oximetry monitors, combined to unfavorably affect gross profit for 2013 by approximately $745,000, or 3% of sales.

During the third quarter of 2013 an impairment charge of $407,000 was recorded pertaining to the Company's first generation FORE-SIGHT monitors. The Company launched its next generation FORE-SIGHT ELITE cerebral oximetry technology during the third quarter of 2013 which offers a significantly enhanced user interface and improved ease-of-use. The Company, therefore, expects that there will be significant demand for the new technology and that many customers currently utilizing the Company's first-generation cerebral oximetry technology under its placement program will seek to upgrade to the latest technology. The new technology has a substantially lower manufacturing cost basis for both monitors and disposable sensors. Although not obligated to do so, the Company will seek to upgrade much of its installed base of placed monitors in the United States. Management conducted an asset impairment analysis with respect to the FORE-SIGHT monitors at customer locations as of the launch date based upon the sum the projected net cash flows through the estimated exchange date. We determined that projected cash flows for certain monitors were less than their carrying value, indicating impairment. We estimated the fair value of the impaired monitors by discounting the projected cash flows using a risk-free rate for the various periods. We determined that an impairment adjustment of $407,000 was required to reduce the net book value of the assets to estimated fair value. In addition, the monitors will be amortized over their adjusted remaining useful life based upon the Company's expected exchange dates which will have the effect of accelerating the amortization of the monitors until they are removed from service. The acceleration of the amortization unfavorably impacted gross profit in the fourth quarter of 2013 by approximately $185,000 and will impact calendar year 2014 by approximately $200,000 compared to the amortization that would have occurred had the upgrades not occurred.

Product mix within the Traditional Monitoring products also impacted gross profit levels for 2013. Lower sales of vital signs monitors to the Veterans Administration were partially offset by increased sales of monitors to non-VA hospital and outpatient surgery partners at lower gross profit rates. Further, as stated earlier, OEM-related price reductions also affected gross profit rates.

R&D expenses increased $191,000, or 5%, to $4,211,000 for 2013 from $4,020,000 for 2012. The increase resulted from reductions in grants and state tax credits totaling $444,000 partially offset by lower clinical evaluation expenses during 2013.

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. The Company's most recent grant has been fully utilized as of December 31, 2012. Amounts reimbursed from the NIH, including accruals, for 2012 were $296,000. In addition, the Company received $44,000 and $148,000 in state tax credits during 2013 and 2012, respectively, which it also credited against R&D expenses.

Selling, general and administrative ("S,G&A") expenses increased $1,263,000, or 10%, to $13,792,000 for 2013 from $12,529,000 for 2012. The increases in S,G&A expenses were primarily related to field sales personnel costs, administrative salaries and related expenses, and legal fees. Medical device excise taxes, effective as of January 1, 2013, accounted for $302,000 of the increase in S,G&A expense.

Interest expense for 2013 reflects the Company's term debt agreement with its bank lender executed July 31, 2012 as described below. Other income for 2013 includes $396,000 of income related to the sale and demutualization of one of the Company's commercial insurance providers.

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There was no income tax benefit for 2013 compared to $211,000 for 2012. 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 Company does not expect to record taxable income during its 2014 fiscal year. Income tax benefits that may be generated during 2014 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, 2013, the deferred income tax asset valuation allowance balance was $9,899,000.

Financial Condition, Liquidity and Capital Resources

The Company's cash, cash equivalents, and short-term investments were $8,190,000 at December 31, 2013, compared to $10,496,000 at December 31, 2012. Working capital decreased $1,888,000 to $10,731,000 at December 31, 2013, from $12,619,000 at December 31, 2012.

The Company's operations used $8,741,000 in cash for 2013. Losses from operations of $10,362,000 were affected by $2,329,000 of depreciation, amortization, impairment of assets, a provision for doubtful accounts, stock compensation expenses, and $708,000 of unfavorable changes in various working capital accounts. During 2012, $5,110,000 of net cash was used by operating activities. Losses from operations for 2012 of $7,308,000 were affected by $1,955,000 of depreciation, amortization, and stock compensation expenses and $243,000 of working capital items primarily related to reductions in inventory.

Net cash provided by investing activities was $246,000 for 2013 compared to cash used of $437,000 for 2012. The Company incurred $1,230,000 of capital expenditures during 2013 compared to $1,565,000 for 2012. For both periods, the expenditures were primarily related to placements of FORE-SIGHT oximeter monitors at customer locations. During 2013 and 2012, $1,251,000 and $1,240,000, respectively, of these certificates of deposit had matured and were transferred to operating cash accounts. Cash flows from investing activities for 2013 include $396,000 of cash from the sale and demutualization of the Company's insurance provider.

As a result of the Company's launch of its next-generation FORE-SIGHT oximetry technology and its planned upgrade of its first-generation FORE-SIGHT oximetry monitors placed with customers in the U.S., the Company expects to incur approximately $1,000,000 of capital expenditures during 2014 and 2015 to upgrade those customers. Under the Company's FORE-SIGHT monitor placement program, customers purchase disposable sensors for use with the Company's equipment. The Company retains title to the monitors shipped to its customers under this program.

The Company also expended $170,000 and $111,000 during 2013 and 2012, respectively, to purchase intangible assets which were primarily related to patent costs and product translations.

Net cash provided by financing activities was $7,440,000 for 2013 compared to cash provided of $3,405,000 for 2012. Cash provided by financing activities in 2013 includes $1,500,000 in proceeds from the Company's amendment of its Loan and Security Agreement (the "Loan Agreement") with East West Bank (the "Bank"). The Company originally entered into the Loan Agreement on July 31, 2012. Pursuant to the Loan Agreement, the Bank provided the Company with a secured three-year $3,500,000 term loan (the "Term Loan") which bears interest at 5.5% and contained a 12-month interest-only feature. On May 10, 2013, the Company amended the Loan Agreement which increased the principal amount to $5,000,000 and extended the maturity date of the Term Loan to July 31, 2016, with principal payable in 24 equal installments of approximately $221,000 including interest commencing August 1, 2014. The interest rate was modified to 5.75%.

The Loan Agreement, as amended, also contains a revolving line-of-credit facility (the "Revolver") with maximum borrowings of $2,000,000 and an expiration date of March 31, 2016. Under the amended 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, 2013. Interest on the loan is payable monthly. The Company is permitted to borrow against eligible accounts receivable as defined under the Revolver according to pre-established criteria. The amount available for borrowing under the Revolver as of December 31, 2013, was $1,284,000. There have been no borrowings under the Revolver since its inception in July 2012.

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The obligations under the Loan Agreement, as amended, are secured by a lien on substantially all assets of the Company, excluding intellectual property, provided that, following an event of default, such security interest would also include intellectual property.

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, 2013, the Company was in compliance with the Loan Agreement covenants.

On July 22, 2013, the Company entered into an underwriting agreement with Northland Securities, Inc. ("Northland") related to the public offering (the "Offering") of 5,200,000 shares of its common stock at $1.25 per share resulting in gross proceeds of $6,500,000. Pursuant to the underwriting agreement, Northland purchased the shares of common stock from the Company at a price of $1.16875 per share. Net proceeds to the Company under the transaction, after fees and expenses, were approximately $5,838,000. Proceeds from the transaction are being used for general corporate purposes.

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, 2013.

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

Operating leases          $ 1,345,000     $   445,000     $     664,000     $     236,000     $            -

The Company's 2014 business plans call for operating expenditures to decrease approximately 5% to 7% from 2013 levels. In early November 2013, the Company implemented certain operating expense reductions affecting personnel and related costs and third-party services in manufacturing, research and development, marketing and general and administrative expenses. Sales related expenditures are estimated to expand in 2014 as the Company continues to build out its global distribution network to sell its new FORE-SIGHT ELITE Oximeter, its new 740 SELECT® and PPM3 vital signs monitors and its new MAX IQ™ non-invasive blood pressure technology.

The next-generation FORE-SIGHT ELITE oximetry technology is expected to provide gross margin enhancements and reduce the Company's capital requirements, particularly in the second half of the year, as the sensor revenue generated from the installed FORE-SIGHT ELITE monitors becomes material. The lower cost of the ELITE technology, especially by comparison to the first-generation FORE-SIGHT monitor, significantly reduces the investment required by the Company where monitors are placed with customers and accelerates our return on invested capital.

The Company's ordinary short-term capital needs are expected to be met from its current cash-on-hand, the net proceeds from the recently completed Offering, and amounts available under within the Revolver 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. There can be no assurance that such additional financing can be obtained on acceptable terms or at all.

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 2013.

Off-Balance Sheet Arrangements

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

- 26 -

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.

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 inventory write-offs for any period presented.

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. 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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