-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, JyBuT02ZrjylvodfQHoNYF10sDjM6qCfoKIwswzcxaBXbnWytXvC5yRNvZ2iE3M9 +Ly/d3WOsJNgkGF+OSmrog== 0000950134-06-017410.txt : 20060907 0000950134-06-017410.hdr.sgml : 20060907 20060907115716 ACCESSION NUMBER: 0000950134-06-017410 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 20060731 FILED AS OF DATE: 20060907 DATE AS OF CHANGE: 20060907 FILER: COMPANY DATA: COMPANY CONFORMED NAME: SYNOVIS LIFE TECHNOLOGIES INC CENTRAL INDEX KEY: 0000780127 STANDARD INDUSTRIAL CLASSIFICATION: ORTHOPEDIC, PROSTHETIC & SURGICAL APPLIANCES & SUPPLIES [3842] IRS NUMBER: 411526554 STATE OF INCORPORATION: MN FISCAL YEAR END: 1031 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-13907 FILM NUMBER: 061078505 BUSINESS ADDRESS: STREET 1: 2575 UNIVERSITY AVENUE CITY: ST PAUL STATE: MN ZIP: 55114-1024 BUSINESS PHONE: 6516033700 FORMER COMPANY: FORMER CONFORMED NAME: BIO VASCULAR INC DATE OF NAME CHANGE: 19920703 10-Q 1 c08305e10vq.txt FORM 10-Q SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For quarterly period ended July 31, 2006 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _________ to _________ Commission File Number 0-13907 ---------- SYNOVIS LIFE TECHNOLOGIES, INC. (Exact name of Registrant as specified in its charter) State of Incorporation: Minnesota I.R.S. Employer Identification No.: 41-1526554 Principal Executive Offices: 2575 University Ave. W. St. Paul, Minnesota 55114 Telephone Number: (651) 796-7300 ---------- Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No --- --- Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of "accelerated filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check one): Large accelerated filer Accelerated Filer X Non-accelerated filer --- --- --- Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes No X --- --- On September 1, 2006, there were 12,066,851 shares of the registrant's common stock, par value $.01 per share, outstanding. PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS SYNOVIS LIFE TECHNOLOGIES, INC. CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS (UNAUDITED) FOR THE THREE AND NINE MONTHS ENDED JULY 31, 2006 AND 2005 (in thousands, except per share data)
Three Months Nine Months Ended Ended July 31, July 31, ----------------- ----------------- 2006 2005 2006 2005 ------- ------- ------- ------- Net revenue $13,051 $15,636 $41,252 $43,425 Cost of revenue 7,918 10,196 25,932 27,358 ------- ------- ------- ------- Gross margin 5,133 5,440 15,320 16,067 Operating expenses: Selling, general and administrative 5,635 4,407 16,665 12,807 Research and development 826 897 2,464 3,069 Other -- 44 -- 130 ------- ------- ------- ------- Operating expenses 6,461 5,348 19,129 16,006 Operating income (loss) (1,328) 92 (3,809) 61 Other income, net 375 263 953 645 ------- ------- ------- ------- Income (loss) before provision (benefit) for income taxes (953) 355 (2,856) 706 Provision (benefit) for income taxes (427) 0 (1,283) 105 ------- ------- ------- ------- Net income (loss) $ (526) $ 355 $(1,573) $ 601 ======= ======= ======= ======= Earnings (loss) per share: Basic $ (0.04) $ 0.03 $ (0.13) $ 0.05 ======= ======= ======= ======= Diluted $ (0.04) $ 0.03 $ (0.13) $ 0.05 ======= ======= ======= =======
The accompanying notes are an integral part of the interim unaudited consolidated condensed financial statements. 2 SYNOVIS LIFE TECHNOLOGIES, INC. CONSOLIDATED CONDENSED BALANCE SHEETS (UNAUDITED) AS OF JULY 31, 2006 AND OCTOBER 31, 2005 (in thousands, except share and per share data)
July 31, October 31, 2006 2005 -------- ----------- ASSETS Current assets: Cash and cash equivalents $ 8,985 $ 8,183 Short-term investments 36,472 36,128 Accounts receivable, net 6,924 8,019 Inventories 9,908 10,500 Deferred income taxes 754 764 Other current assets 1,318 1,839 ------- ------- Total current assets 64,361 65,433 Property, plant and equipment, net 12,555 13,931 Goodwill, net 5,434 5,335 Other intangible assets, net 2,028 2,264 Deferred income taxes 943 -- ------- ------- Total assets $85,321 $86,963 ======= ======= LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable $ 1,483 $ 2,711 Accrued expenses 4,223 3,355 ------- ------- Total current liabilities 5,706 6,066 Deferred income taxes -- 555 ------- ------- Total liabilities 5,706 6,621 ------- ------- Shareholders' equity: Preferred stock: authorized 5,000,000 shares of $.01 par value; none issued or outstanding at July 31, 2006 and October 31, 2005 -- -- Common stock: authorized 20,000,000 shares of $.01 par value; issued and outstanding, 12,059,651 at July 31, 2006 and 11,933,628 at October 31, 2005 121 119 Additional paid-in capital 74,914 74,070 Retained earnings 4,580 6,153 ------- ------- Total shareholders' equity 79,615 80,342 ------- ------- Total liabilities and shareholders' equity $85,321 $86,963 ======= =======
The accompanying notes are an integral part of the interim unaudited consolidated condensed financial statements. 3 SYNOVIS LIFE TECHNOLOGIES, INC. CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS (UNAUDITED) FOR THE NINE MONTHS ENDED JULY 31, 2006 AND 2005 (in thousands)
Nine Months Ended July 31, ------------------- 2006 2005 -------- -------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income (loss) $ (1,573) $ 601 Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depreciation of property, plant and equipment 2,577 2,121 Amortization of intangible assets 336 312 Tax benefit from exercise of stock options -- 127 Stock-based compensation 136 -- Loss on disposal of manufacturing equipment -- 268 Deferred income taxes (1,488) (160) Changes in operating assets and liabilities: Accounts receivable 1,095 (510) Inventories 592 1,216 Other current assets 521 353 Accounts payable (1,318) (2,061) Accrued expenses 868 788 -------- -------- Net cash provided by operating activities 1,746 3,055 -------- -------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchase of property, plant and equipment (1,111) (2,567) Investment in patents and trademarks (100) (86) Purchase of short-term investments (11,656) (60,464) Redemption of short-term investments 11,312 51,350 Purchase of assets of Neuroregen, LLC -- (986) Other (99) (59) -------- -------- Net cash used in investing activities (1,654) (12,812) -------- -------- CASH FLOWS FROM FINANCING ACTIVITIES: Net proceeds related to stock-based compensation plans 710 794 Repayment of capital lease and other long-term obligations -- (28) -------- -------- Net cash provided by financing activities 710 766 -------- -------- NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 802 (8,991) CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 8,183 15,369 -------- -------- CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 8,985 $ 6,378 ======== ========
The accompanying notes are an integral part of the interim unaudited consolidated condensed financial statements. 4 SYNOVIS LIFE TECHNOLOGIES, INC. NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (UNAUDITED) (1) BASIS OF PRESENTATION: The accompanying unaudited consolidated condensed financial statements of Synovis Life Technologies, Inc. ("Synovis" or the "Company") have been prepared by the Company in accordance with generally accepted accounting principles applied in the United States for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. For further information, refer to the consolidated financial statements and notes thereto included in the Company's Annual Report on Form 10-K for the year ended October 31, 2005. In the opinion of management, all adjustments considered necessary, consisting only of items of a normal recurring nature, for a fair presentation of the consolidated financial position, results of operations and cash flows of the Company as of and for the interim periods presented have been included. Operating results and cash flows for the three and nine months ended July 31, 2006 are not necessarily indicative of the results of operations and cash flows of the Company that may be expected for the year ending October 31, 2006. All amounts included in the Notes to Consolidated Condensed Financial Statements are in thousands, except for share and per share data, and as specified otherwise. (2) SUPPLEMENTAL FINANCIAL STATEMENT INFORMATION:
July 31, October 31, 2006 2005 -------- ----------- Inventories consist of the following: Finished goods ......................... $2,708 $ 3,006 Work in process ........................ 4,086 4,651 Raw materials .......................... 3,114 2,843 ------ ------- $9,908 $10,500 ====== =======
Cash Flow: The Company has recorded $90 in accounts payable at July 31, 2006 related to equipment purchases made during the quarter then ended. Contingency: In October 2005, one of the third party distributors of our surgical business commenced an arbitration action alleging, among other claims, that we had repudiated the parties' distribution agreement. The Company has formally disputed the distributor's claims and asserted counterclaims alleging distributor failure to perform under the terms of the contract. The arbitration for this matter is now currently scheduled for January 2007. The Company is unable to evaluate the likelihood of prevailing in this case at this early stage of the proceedings and has not recorded a liability in the consolidated condensed balance sheet. As of July 31, 2006, the Company had accounts receivable of $449 from this distributor for product sales made prior to the commencement of the arbitration action. 5 SYNOVIS LIFE TECHNOLOGIES, INC. NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (UNAUDITED) - (CONTINUED) (3) GOODWILL AND OTHER INTANGIBLE ASSETS: The following table summarizes the Company's amortized intangible assets:
As of July 31, As of October 31, 2006 2005 ----------------------- ----------------------- Gross Gross Carrying Accumulated Carrying Accumulated Amount Amortization Amount Amortization -------- ------------ -------- ------------ Amortized intangible assets: Patents and trademarks $1,638 $ 669 $1,546 $ 572 Developed technology 1,102 562 1,102 480 Non-compete agreements 1,500 981 1,500 832 ------ ------ ------ ------ Total $4,240 $2,212 $4,148 $1,884 ====== ====== ====== ======
Amortization expense was $336 for the nine months ended July 31, 2006 and $312 for the nine months ended July 31, 2005. The estimated amortization expense for each of the next five years is approximately $450 per year, based on the Company's present intangible assets. The following is a summary of goodwill by business segment:
Interventional Surgical business business Total -------------- -------- ------ Goodwill as of: July 31, 2006 $4,093 $1,341 $5,434 October 31, 2005 $4,093 $1,242 $5,335
No impairment losses were incurred during the nine months ended July 31, 2006. (4) STOCK-BASED COMPENSATION: On February 28, 2006, shareholders approved the Company's 2006 Stock Incentive Plan (the "2006 Plan"). The 2006 Plan permits the Company to grant incentive stock options, non-qualified stock options or share awards to eligible recipients for up to one million shares of its common stock, plus the number of shares subject to outstanding awards under the 1995 Plan as of its expiration which are subsequently cancelled or forfeited. The grant price of an option under the 2006 Plan may not be less than the fair market value of the common stock subject to the option as of the grant date. The term of any options granted under the 2006 Plan may not exceed seven years from the date of grant. As of July 31, 2006, no stock options or share awards have been granted under the 2006 Plan. The Company also has an Employee Stock Purchase Plan ("ESPP"), which permits employees to purchase stock at 95% of the market price of its common stock at the end of each quarterly purchase period. No stock-based compensation expense for the ESPP is required to be recorded based on the provisions of Statement of Financial Accounting Standards ("SFAS") No. 123 (revised 2004), Shared-Based Payment ("SFAS No. 123R"). Prior to November 1, 2005, the Company applied Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations in accounting for these plans. No stock-based compensation expense was recognized in the Company's statements of operations prior to fiscal 2006 for stock option awards, as the exercise price was equal to the market price of the Company's stock on the date of grant. In addition, the Company did not recognize any stock-based compensation expense for its ESPP. 6 SYNOVIS LIFE TECHNOLOGIES, INC. NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (UNAUDITED) - (CONTINUED) On November, 1, 2005, the Company adopted the fair value recognition provisions of SFAS No. 123R, requiring the Company to recognize expense related to the fair value of our stock-based compensation awards. The Company elected the modified prospective transition method as permitted by SFAS No. 123R. Under this transition method, stock-based compensation expense for the three and nine months ended July 31, 2006, includes compensation expense for all stock-based compensation awards granted prior to, but not yet vested, as of October 31, 2005, based on the grant date fair value estimated in accordance with the original provisions of SFAS No. 123, Accounting for Stock-Based Compensation ("SFAS No. 123"). The Company recognized compensation expense for stock options on a straight-line basis over the requisite service period of the award. Total stock-based compensation expense included in the Company's statements of operations for the three and nine months ended July 31, 2006, was $35 ($22, net of tax) and $136 ($86, net of tax), respectively. In accordance with the modified prospective transition method of SFAS No. 123R, financial results for prior periods have not been restated. The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of SFAS No. 123 to stock-based employee compensation:
Three Months Ended Nine Months Ended July 31, July 31, 2005 2005 ------------------ ----------------- Net income, as reported $ 355 $ 601 Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects 265 757 ----- ------ Net income (loss), pro forma $ 90 $ (156) ===== ====== Basic earnings (loss) per share: As reported $0.03 $ 0.05 ===== ====== Pro forma $0.01 $(0.01) ===== ====== Diluted earnings (loss) per share: As reported $0.03 $ 0.05 ===== ====== Pro forma $0.01 $(0.01) ===== ======
For purposes of this pro forma disclosure, the value of the stock-based compensation was amortized to expense on a straight-line basis over the period it vested. The Black-Scholes option valuation weighted average assumptions used in the pro forma disclosure under SFAS No. 123 for the nine months ended July 31, 2005 were as follows: Risk-free rate (1) 3.8% Expected dividend yield None Expected stock volatility (2) 72% Expected life of stock options (3) 3.0 years Fair value per option $4.39 - $7.13
(1) Based on the U.S Treasury Strip interest rates whose term is consistent with the expected life of the stock options. (2) Expected stock price volatility is based on historical experience. (3) Expected life of stock options is based on historical experience. 7 SYNOVIS LIFE TECHNOLOGIES, INC. NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (UNAUDITED) - (CONTINUED) The following table summarizes the stock option transactions:
Weighted Weighted Average Average Remaining Exercise Contractual Aggregate Stock Price Term (in Intrinsic Options per Share years) Value -------- --------- ----------- --------- Outstanding on October 31, 2005 919,199 $8.54 Granted -- -- Exercised (115,047) $5.32 Forfeited/cancelled (45,502) $9.92 -------- ----- Outstanding on July 31, 2006 758,650 $8.94 3.46 $1,035 ======== ===== ==== ====== Exercisable on July 31, 2006 714,650 $8.80 3.19 $1,035 ======== ===== ==== ======
The total intrinsic value of options exercised during the nine months ended July 31, 2006 was $498. The Company estimated the fair values of its stock options using the Black-Scholes option-pricing model for all options granted prior to November 1, 2005. During the nine months ended July 31, 2006, the Company did not grant any stock options, and thus, has not used an option-pricing model. The Company is presently evaluating a stock-based compensation strategy for its employees and non-employee directors, as well as an option-pricing model the Company believes will most accurately estimate the fair value of options granted. As of July 31, 2006, there was $59 of unrecognized compensation expense related to nonvested stock options that is expected to be recognized over a weighted average period of six months. (5) EARNINGS PER SHARE: The following table sets forth the presentation of shares outstanding used in the calculation of basic and diluted earnings per share:
Three Months Ended Nine Months Ended July 31, July 31, ----------------------- ----------------------- 2006 2005 2006 2005 ---------- ---------- ---------- ---------- Denominator for basic earnings per share - weighted-average common shares ................ 12,035,252 11,808,938 11,979,114 11,766,187 Shares associated with option plans .............. -- 175,708 -- 242,227 ---------- ---------- ---------- ---------- Denominator for diluted earnings per share - weighted-average common shares and dilutive potential common shares ....................... 12,035,252 11,984,646 11,979,114 12,008,414 ========== ========== ========== ========== Options excluded from EPS calculation because exercise prices are greater than the average market price of the Company's common stock .... 422,749 293,387 391,809 243,400 ========== ========== ========== ==========
8 SYNOVIS LIFE TECHNOLOGIES, INC. NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (UNAUDITED) - (CONTINUED) For the three and nine months ended July 31, 2006, none of the options outstanding were included in the computation of diluted earnings per share because the Company incurred a net loss, and the inclusion of the options would have been anti-dilutive. (6) SEGMENT INFORMATION: The Company's operations, which are based mainly in Minnesota and Puerto Rico, are comprised of two operating segments, the surgical business and the interventional business, with segmentation based upon the similarities of the underlying business operations, products and markets of each. The Company evaluates the performance of its business segments and allocates resources based upon their respective current or future earnings contribution to the consolidated earnings of the Company or based upon the segment's product research and development efforts in process at that time. Operations that are not included in either of the operating segments are included in the category "corporate and other." The corporate and other segment captures costs that are not directly assignable to one of the operating business segments, including the costs of being a public company and the unallocated time of management personnel who support corporate activities. The following table presents certain financial information by business segment:
Three Months Ended Nine Months Ended July 31, July 31, ------------------ ----------------- 2006 2005 2006 2005 ------- ------- ------- ------- Net revenue: Surgical business $ 7,341 $ 6,608 $19,692 $19,101 Interventional business 5,710 9,028 21,560 24,324 ------- ------- ------- ------- Consolidated $13,051 $15,636 $41,252 $43,425 ======= ======= ======= ======= Operating income (loss): Surgical business $ (27) $ 428 $(1,052) $ 1,517 Interventional business (717) 171 (1,065) 65 Corporate and other (584) (507) (1,692) (1,521) ------- ------- ------- ------- Consolidated $(1,328) $ 92 $(3,809) $ 61 ======= ======= ======= =======
(7) SHAREHOLDERS' EQUITY: During the nine months ended July 31, 2006, stock options for the purchase of 115,047 shares of the Company's common stock were exercised at prices between $2.69 and $8.30 per share. During the nine months ended July 31, 2005, stock options for the purchase of 115,337 shares of the Company's common stock were exercised at prices between $2.59 and $10.07 per share. 9 SYNOVIS LIFE TECHNOLOGIES, INC. NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (UNAUDITED) - (CONTINUED) On June 1, 2006, the Company's board of directors declared a dividend distribution of one common stock purchase right for each outstanding share of the Company's common stock, payable to shareholders of record at the close of business on June 11, 2006. The description and terms of the rights are set forth in a Rights Agreement (the "Rights Agreement"), dated as of June 1, 2006, between the Company and American Stock Transfer & Trust Company, as Rights Agent. The Rights Agreement will be included as a proposal to be voted on by shareholders at the Company's Annual Meeting of Shareholders. Upon certain acquisition events set forth in the Rights Agreement, each holder of a right other than certain "acquiring persons," will have the right to receive upon exercise for a purchase price equal to ten times the purchase price of the right, shares of Company common stock (or in certain circumstances, cash, property or other securities) having a market value equal to twenty times the purchase price. The Rights Agreement is intended to extend protections similar to those provided by the Company's previous rights agreement which expired on June 11, 2006. (8) SHORT-TERM INVESTMENTS: The Company's short-term investments consist of high-grade, tax-exempt auction rate securities and municipal bonds. These investments, a portion of which have stated original maturities beyond one year, are classified as short-term based on their highly liquid nature. The securities which have original maturities beyond one year have certain economic characteristics of short-term investments due to a rate-setting mechanism and the ability to sell them through a Dutch auction process that occurs at pre-determined intervals of less than one year. The Company's short-term investments are classified as available-for-sale securities and the carrying value of these securities approximates fair market value due to their highly liquid nature. As of July 31, 2006 and October 31, 2005, there were no unrealized gains or losses associated with these investments. The Company had $36,472 and $36,128 in short-term investments as of July 31, 2006 and October 31, 2005, respectively. 10 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Forward-Looking Statements: The disclosures in this Form 10-Q include "forward-looking statements" made under the Private Securities Litigation Reform Act of 1995. Without limiting the foregoing, words such as "should", "could", "may", "will", "expect", "believe", "anticipate", "estimate" or "continue" or the negative or other variations thereof or comparable terminology are intended to identify forward-looking statements. All forward-looking statements in this document are based on information available to the Company as of the date hereof, and the Company assumes no obligation to update any forward-looking statements. You are advised, however, to consult any future disclosures we make on related subjects in future filings with the SEC. Forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause the actual results to differ materially from any future results, performance or achievements expressed or implied by such forward-looking statements. Certain important factors that could cause results to differ materially from those anticipated by the forward-looking statements made herein include the timing of product introductions, outcomes of clinical and market trials as well as regulatory submissions, the number of certain surgical procedures performed, the ability to identify, acquire and successfully integrate suitable acquisition candidates, the cost and outcome of intellectual property litigation, the level and timing of orders from contract manufacturing customers and the effectiveness of the company's transition to a domestic direct sales force in its surgical business, as well as other factors found in the Company's filings with the SEC, such as the "Risk Factors" section in Item 1A of the Annual Report on Form 10-K for the year ended October 31, 2005. BUSINESS OVERVIEW Synovis Life Technologies, Inc. is a diversified medical device company engaged in developing, manufacturing, marketing and selling products for the surgical and interventional treatment of disease. Our business is conducted in two operating segments, the surgical business and the interventional business, with segmentation based upon the similarities of the underlying business operations, products and markets of each. Our surgical business develops, manufactures, markets and sells implantable biomaterial products, devices for microsurgery and surgical tools, all designed to reduce risk and/or facilitate critical surgeries, leading to better patient outcomes and/or lower costs. Our interventional business develops, engineers, prototypes and manufactures coils, helices, stylets, guidewires and other complex micro-wire, polymer and micro-machined metal components used in interventional devices for cardiac rhythm management, neurostimulation, vascular and other procedures. In addition, our interventional business designs and develops proprietary technology platforms which can be adapted for our customers. Operations that are not included in either of the operating segments are reported in the category "corporate and other." The corporate and other segment captures costs that are not directly assignable to one of the operating business segments, including the costs of operating a public company and the estimated time of management personnel in support of corporate activities. 11 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - CONTINUED RESULTS OF OPERATIONS COMPARISON OF THE THREE MONTHS ENDED JULY 31, 2006 WITH THE THREE MONTHS ENDED JULY 31, 2005 ($ IN THOUSANDS EXCEPT PER SHARE DATA) The following table summarizes our condensed consolidated operating results:
For the quarter For the quarter ended July 31, ended July 31, 2006 2005 Change --------------- --------------- ---------------- $ % $ % $ % ------- ----- ------- ----- ------- ------ Net revenue $13,051 100.0% $15,636 100.0% $(2,585) (16.5%) Cost of revenue 7,918 60.7 10,196 65.2 (2,278) (22.3) ------- ----- ------- ----- ------- ------ Gross margin 5,133 39.3 5,440 34.8 (307) (5.6) Selling, general and administrative 5,635 43.2 4,407 28.2 1,228 27.9 Research and development 826 6.3 897 5.7 (71) (7.9) Other -- 0.0 44 0.3 (44) (100.0) ------- ----- ------- ----- ------- ------ Operating expenses 6,461 49.5 5,348 34.2 1,113 20.8 ------- ----- ------- ----- ------- ------ Operating income (loss) $(1,328) (10.2%) $ 92 0.6% $(1,420) n.m. ======= ===== ======= ===== ======= ======
The following table summarizes our condensed consolidated operating results by business segment:
For the quarter ended July 31, ----------------- 2006 2005 ------- ------- Net revenue Surgical business $ 7,341 $ 6,608 Interventional business 5,710 9,028 ------- ------- Consolidated $13,051 $15,636 Gross margin Surgical business $ 4,284 $ 3,484 Interventional business 849 1,956 ------- ------- Consolidated $ 5,133 $ 5,440 Gross margin percentage Surgical business 58% 53% Interventional business 15% 22% Consolidated 39% 35% Operating income (loss) Surgical business $ (27) $ 428 Interventional business (717) 171 Corporate and other (584) (507) ------- ------- Consolidated $(1,328) $ 92
12 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - CONTINUED Our interventional business customers predominantly operate in the cardiac rhythm management ("CRM") market and we address three segments of this market: pacing, implantable cardioverter defibrillation ("ICD") and congestive heart failure ("CHF"). Within the CRM market, we produce conductor and shocking coils for pacing and defibrillator leads, helices for active fixation leads, and stylets used to implant all types of leads. Our interventional business has customarily experienced variations in revenue from period to period primarily due to inherent variability in the timing of customer demand. Such variations may continue in the future. The following table summarizes our interventional business net revenue by market:
For the quarter ended July 31, --------------- 2006 2005 ------ ------ Cardiac rhythm management $3,979 $7,333 Other 1,731 1,695 ------ ------ Total $5,710 $9,028
The following table summarizes our interventional business net revenue by product group:
For the quarter ended July 31, --------------- 2006 2005 ------ ------ Coils and helices $2,644 $5,355 Stylets and other wireforms 1,924 2,501 Machining, molding and tool making 925 789 Other 217 383 ------ ------ Total $5,710 $9,028
Interventional business net revenue decreased $3,318 or 37% to $5,710 in the third quarter of fiscal 2006 from $9,028 in the third quarter of fiscal 2005. Sales to our interventional businesses' three largest customers collectively accounted for 73% and 85% of revenue in the third quarter of fiscal 2006 and 2005, respectively. Our interventional business is indirectly affected by the market conditions and trends of the CRM market, and we are directly affected by the actions of our customers in response to this market. The entire revenue decrease in the third quarter of the current year occurred in the CRM market, which decreased $3,354. We believe certain of our CRM customer's sales have been affected by softness in the CRM market due to recalls of ICDs (implantable cardioverter defibrillators) and product concerns among patients and cardiologists, which has lead to lower inventory requirements. In addition, one significant CRM customer launched a new ICD lead, which may replace certain existing leads for which we supply the coils. During the current quarter, the customer significantly reduced purchases of the coils we supply. Approximately half of our interventional business decrease was due to a decrease in the sale of these coils. Early in the fourth quarter, customer orders for the coils we manufacture have increased from third quarter levels, however, we do not expect them to approach the quarterly sales levels during the first half of the year. We anticipate we will have an opportunity to qualify for future generations of these products. 13 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - CONTINUED Our surgical business generated net revenue of $7,341 in the third quarter of fiscal 2006, an 11% increase from $6,608 in the year-ago quarter. The following table summarizes our surgical business net revenue by product group:
For the quarter ended July 31, --------------- 2006 2005 ------ ------ Peri-Strips(R) ("PSD") $2,640 $2,096 Other biomaterial products 2,674 2,323 Devices for microsurgery 993 772 Surgical tools and other 1,034 1,417 ------ ------ Total $7,341 $6,608
Our surgical business is currently transitioning to a direct sales force in the U.S. market for all products except devices for microsurgery (the "Transition"), and has completed the hiring of its 24 direct sales representatives. As a result of the Transition, we have higher average selling prices due to selling our products at hospital list price as opposed to previously selling to stocking distributors at a discount from list price. Offsetting the higher average selling prices are commissions paid to former stocking distributors now serving as independent sales representatives as part of their Transition agreements. These commissions are paid on sales in their territories for a contracted period of time after they cease to be a stocking distributor. Most of our domestic distributors entered into this independent sales representative phase during the second quarter and completed the phase during the third quarter of fiscal 2006. As a result of the phase out, third-party commission expense was $661 in the third quarter of fiscal 2006. Commission expense will decrease appreciably over the remaining calendar year as we conclude the transition periods with our third-party sales representatives. The increase in surgical business net revenue in the third quarter of fiscal 2006 compared to the prior-year quarter was primarily due to following factors: - - First, higher net selling prices increased surgical business revenue by approximately 13%. The higher prices are primarily the result of the Transition, along with select list price increases. - - Secondly, higher worldwide volumes sold in the current period quarter increased revenue by approximately 7%. - - Partially offsetting this increase, our fiscal 2005 discontinuation of the Biograft product line, which became cost prohibitive to manufacture due to new regulatory requirements. Revenue from Biograft in the third quarter of fiscal 2005 totaled $583. Worldwide net revenue from Peri-Strips, which includes revenue from PSD Veritas and PSD Circular, was $2,640 in the third quarter of fiscal 2006, an increase of $544 or 26% from $2,096 in the third quarter of fiscal 2005. The increase was driven by increased net selling prices due to the Transition, product mix changes within the Peri-Strips product family, an 11% increase in domestic units sold, and new revenue from our PSD Circular product. Revenue from other biomaterial products increased 15% to $2,674 in the third quarter of fiscal 2006 from $2,323 in the prior-year quarter. Higher net selling prices due to the Transition and a fiscal 2006 second quarter international list price increase, combined with a 7% worldwide sales unit increase, drove the current quarter revenue increase over the prior-year quarter. Revenue from devices for microsurgery was $993 in the third quarter of fiscal 2006, an increase of $221 or 29% from $772 in the year-ago quarter. Driving this increase was increased Coupler sales and revenue from S&T instruments. In March 2006, we entered into an agreement to be the exclusive U.S. distributor of the S&T microsurgery product line. 14 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - CONTINUED Our surgical tools and other product line decreased $383 or 27% to $1,034 in the third quarter of fiscal 2006, primarily due to our fiscal 2005 discontinuation of the Biograft product line as noted above. Partially offsetting this was shipping revenue, which increased $137 to $228 in the third quarter of fiscal 2006, primarily due to the higher volume of individual shipments made due to the Transition. Our consolidated gross margin increased four percentage points to 39% in the third quarter of fiscal 2006 from 35% during the third quarter of fiscal 2005. The margin increase was due to a higher proportion of surgical business revenue and the increased gross margin within this segment, offset partially by the decrease in the interventional business gross margin. Gross margin in the interventional business decreased seven percentage points in the current quarter of fiscal 2006 compared to the prior-year quarter, from 22% to 15%. The decrease from the prior-year quarter was primarily due to product mix and higher overhead rates due to lower production hours as a result of lower sales volumes. Partially mitigating these items were cost savings realized in the quarter from the reorganization of certain functional areas that occurred in the second quarter of fiscal 2006. In our surgical business, the gross margin increased five percentage points in the third quarter of fiscal 2006 compared to the same quarter of fiscal 2005, from 53% to 58%, due primarily to three factors: - Higher selling prices of certain of our products resulting from our ongoing Transition benefited the current quarter gross margin by approximately three percentage points. - Our Biograft inventory liquidation and disposition adversely impacted the third quarter gross margin of fiscal 2005. The benefit of the current quarter compared to the prior-year quarter is approximately six percentage points. - Partially offsetting the increase, higher production and overhead rates associated with the manufacture of products in fiscal 2006 as compared to the prior year have decreased the gross margin by approximately three percentage points. Factors which affect the consolidated gross margin include the relative revenue of each business segment, product mix within each business segment, average net selling prices, volume, product acquisitions and disposals, and other production activities. Accordingly, our consolidated gross margin may fluctuate from period to period based on variations in these factors. In fiscal 2006, we are incurring significantly greater selling, general and administrative ("SG&A") expense within our surgical business compared to fiscal 2005 due to the Transition, which is expected to result in approximately $4,000 of incremental expense in the current year. SG&A expense during the third quarter of fiscal 2006 was $5,635, an increase of $1,228 or 28% as compared to $4,407 in the third quarter of fiscal 2005. As a percentage of net revenue, SG&A expense was 43% in the third quarter of fiscal 2006 as compared to 28% in the prior-year quarter. Approximately $1,139 of the increase was due to the expected increased selling costs related to our Transition. These costs include the hiring and training of our sales force, as well as their compensation and business related expenses. Research and development ("R&D") expense decreased 8% during the third quarter of fiscal 2006 to $826 from $897 during the prior-year quarter. This decrease was due to the timing and nature of various projects. In both business units R&D expense fluctuates from quarter to quarter based on the timing and progress of internal and external project-related activities, and the timing of such expense will continue to be influenced primarily by the number of projects and the related R&D personnel requirements, development and regulatory approval path, expected costs, timing and nature of those costs for each project. 15 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - CONTINUED Due to the above factors, we recorded an operating loss of $1,328 in the third quarter of fiscal 2006, as compared to operating income of $92 in the third quarter of fiscal 2005. Interest income increased to $375 in the third quarter of fiscal 2006 compared with $263 in the comparable quarter of fiscal 2005, primarily due to higher investment yields in the current-year period. We recorded a benefit from income taxes of $427 in the third quarter of fiscal 2006, at an effective rate of 45%. This compares to a provision for income taxes of $0 in the prior year quarter. On a year-to-date basis, our benefit from income taxes reflects an effective tax rate of 45%, which is our current expected tax rate for fiscal 2006. Our effective rate in fiscal 2006 is expected to be sensitive to the level of tax-exempt interest income, R&D credits and other permanent tax items relative to pre-tax income (loss). Through the third quarter of fiscal 2006, we have not recorded any benefit for federal R&D tax credits as the law governing this benefit expired in 2005 and has not yet been renewed. If the federal R&D credit law is reinstated, we will recognize additional income tax benefit in the quarter of the reinstatement. On August 18, 2006, Synovis initiated a patent infringement action in U.S. District Court against Cook Group, Inc., an Indiana-based company. The action alleges infringement of U.S. Patent No. 5,752,965 "Apparatus and Method for Producing a Reinforced Surgical Fastener Suture Line," which covers certain surgical business technology. We intend to vigorously protect our intellectual property, however, there can be no assurances our action will prevail at this early stage. In addition, we may incur significant expense related to this action in the future, with the amount and timing of such expense dependant upon many variables. COMPARISON OF THE NINE MONTHS ENDED JULY 31, 2006 WITH THE NINE MONTHS ENDED JULY 31, 2005 ($ IN THOUSANDS EXCEPT PER SHARE DATA) The following table summarizes our condensed consolidated operating results:
For the nine For the nine months ended months ended July 31, 2006 July 31, 2005 Change --------------- --------------- ---------------- $ % $ % $ % ------- ----- ------- ----- ------- ------ Net revenue $41,252 100.0% $43,425 100.0% $(2,173) (5.0%) Cost of revenue 25,932 62.9 27,358 63.0 (1,426) (5.2) ------- ----- ------- ----- ------- ------ Gross margin 15,320 37.1 16,067 37.0 (747) (4.6) Selling, general and administrative 16,665 40.4 12,807 29.5 3,858 30.1 Research and development 2,464 5.9 3,069 7.1 (605) (19.7) Other -- 0.0 130 0.3 (130) (100.0) ------- ----- ------- ----- ------- ------ Operating expenses 19,129 46.3 16,006 36.9 3,123 19.5% ------- ----- ------- ----- ------- ------ Operating income (loss) $(3,809) (9.2%) $ 61 0.1% $(3,870) n.m. ======= ===== ======= ===== ======= ======
The following table summarizes our condensed consolidated operating results by business segment:
For the nine months ended July 31, ----------------- 2006 2005 ------- ------- Net revenue Surgical business $19,692 $19,101 Interventional business 21,560 24,324 ------- ------- Consolidated $41,252 $43,425
16 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - CONTINUED Gross margin Surgical business $11,291 $10,976 Interventional business 4,029 5,091 ------- ------- Consolidated $15,320 $16,067 Gross margin percentage Surgical business 57% 57% Interventional business 19% 21% Consolidated 37% 37% Operating (loss) income Surgical business $(1,052) $ 1,517 Interventional business (1,065) 65 Corporate and other (1,692) (1,521) ------- ------- Consolidated $(3,809) $ 61
The following table summarizes our interventional business net revenue by market:
For the nine months ended July 31, ----------------- 2006 2005 ------- ------- Cardiac rhythm management $15,743 $19,113 Other 5,817 5,211 ------- ------- Total $21,560 $24,324
The following table summarizes our interventional business net revenue by product group:
For the nine months ended July 31, ----------------- 2006 2005 ------- ------- Coils and helices $11,188 $13,050 Stylets and other wireforms 6,362 7,598 Machining, molding and tool making 2,931 2,723 Other 1,079 953 ------- ------- Total $21,560 $24,324
Interventional business net revenue decreased 11% to $21,560 in the first nine months of fiscal 2006 from $24,324 in the first nine months of fiscal 2005. The revenue decrease was entirely due to decreased revenue within our CRM market in the third quarter due to the factors provided in the third quarter discussion. Revenue from our interventional businesses' three largest customers decreased approximately $3,100 in the current year compared to the prior year, and collectively accounted for 77% and 81% of revenue in the first nine months of fiscal 2006 and 2005, respectively. Interventional business revenue from other markets increased $606 or 12% in the first nine months of fiscal 2006 compared to the prior year, driven by increased product sales into the neuro and vascular markets. 17 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - CONTINUED The following table summarizes our surgical business net revenue by product group:
For the nine months ended July 31, ----------------- 2006 2005 ------- ------- Peri-Strips $ 6,733 $ 6,979 Other biomaterial products 7,438 6,605 Devices for microsurgery 2,711 2,052 Surgical tools and other 2,810 3,465 ------- ------- Total $19,692 $19,101
Revenue in our surgical business was $19,692 in the first nine months of fiscal 2006, an increase of $591 or 3% from the first nine months of fiscal 2005. The increase was largely driven by higher net selling prices due to the Transition, which increased surgical business revenue by 10%. Partially offsetting this increase were lower volumes of worldwide units sold, due largely to lower sales of Peri-Strips. In addition, our Biograft discontinuation had a 5% impact on surgical revenue, as revenue from Biograft in the first three quarters of fiscal 2005 totaled $1,050. Worldwide net revenue from Peri-Strips, which includes revenue from PSD Veritas and PSD Circular, was $6,733 in the first nine months of fiscal 2006, a decrease of 4% from $6,979 in the first nine months of fiscal 2005. Lower domestic units sold in the first nine months of fiscal 2006, partially offset by higher selling prices, drove the revenue decrease. Revenue from other biomaterial products increased 13% to $7,438 in the first three quarters of fiscal 2006. Higher net selling prices due to the Transition and a second quarter international list price increase, combined with a 9% worldwide sales unit increase, drove the current period revenue increase over the prior-year period. Revenue from devices for microsurgery was $2,711 in the first nine months of fiscal 2006, an increase of $659 or 32% from $2,052 in the year-ago period. Driving this increase were increased Coupler sales and revenue from S&T instruments. Our surgical tools and other product line decreased $655 or 19% to $2,810 in the first three quarters of fiscal 2006, primarily due to our fiscal 2005 discontinuation of the Biograft product line. Revenue from Biograft in the first nine months of fiscal 2005 totaled $1,050. Partially offsetting this was shipping revenue, which increased $350 to $592 in the first nine months of fiscal 2006, primarily due to the higher volume of individual shipments made due to the Transition. Our consolidated gross margin was 37% in each of the first nine months of fiscal 2006 and 2005. Business unit mix increased the gross margin by approximately two percentage points, offset by a lower gross margin within our interventional business during the year-to-date fiscal period. Gross margin in the interventional business decreased two percentage points to 19% in the first nine months of fiscal 2006 from 21% in the first nine months of fiscal 2005. The decrease in the current year gross margin was primarily attributable to product mix and higher overhead rates. In our surgical business, the gross margin was 57% in each of the first three quarters of fiscal 2006 and 2005, respectively. The following shifts occurred within the surgical business gross margin for the current year: - Higher selling prices of certain of our products resulting from our ongoing Transition benefited the gross margin by approximately two percentage points. - In addition, our Biograft inventory liquidation and disposition adversely impacted the gross margin of fiscal 2005. The benefit of the current year compared to the prior-year quarter was approximately three percentage points. 18 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - CONTINUED - Offsetting the above factors, lower production volumes, thereby resulting in higher overhead rates, lower utilization of manufacturing resources and higher scrap rates, decreased the gross margin by approximately five percentage points. SG&A expense during the first nine months of fiscal 2006 was $16,665, an increase of $3,858 or 30% as compared to $12,807 in the first nine months of fiscal 2005, due primarily to costs related to the Transition of $2,711. In addition, $409 of the increase was related to our now discontinued colorectal clinical market evaluation using Veritas PSD. As a percentage of net revenue, SG&A expense was 40% in year-to-date period of fiscal 2006 as compared to 30% in the prior year period. R&D expense decreased 20% during the first three quarters of fiscal 2006 to $2,464 from $3,069 during the prior-year period. This decrease was due to the timing and nature of various projects, most notably $354 related to two studies utilizing circular PSD Veritas within our surgical business during the first nine months of fiscal 2005. During the first nine months of fiscal 2005, we recorded expense of $130 related to legal and other fees in connection with certain lawsuits filed against the Company, which were subsequently dismissed. Due to the above factors, we have recorded an operating loss of $3,809 in the first nine months of fiscal 2006, as compared to operating income of $61 in the first nine months of fiscal 2005. Interest income increased to $953 in the first nine months of fiscal 2006 compared with $645 in the same period of fiscal 2005, primarily due to higher investment yields in the current-year period. Our effective tax rate on a year to date basis is 45%. We recorded a benefit from income taxes of $1,283 in the first nine months of fiscal 2006 as compared to a provision for income taxes of $105 in the first nine months of fiscal 2005. Our effective tax rate in fiscal 2006 is expected to be sensitive to the level of tax-exempt interest income, R&D credits and other permanent items relative to pre-tax income. LIQUIDITY AND CAPITAL RESOURCES Cash and cash equivalents were $8,985 at July 31, 2006 as compared to $8,183 at October 31, 2005, an increase of $802. The increase in cash was primarily related to changes in working capital in the first nine months of fiscal 2006. Operating activities provided cash of $1,746 in the first nine months of fiscal 2006, as compared to providing cash of $3,055 during the first nine months of fiscal 2005. The decrease in cash provided by operating activities was largely due to our net loss in the fiscal 2006 period combined with an increase in deferred taxes driven by our net operating loss carryforward. Working capital provided cash of $1,758 in the first nine months of fiscal 2006, an increase of $1,972 over the prior year due to lower inventory and accounts receivable balances. Investing activities used $1,654 of cash during the first three quarters of fiscal 2006 compared to $12,812 in the prior-year period. In fiscal 2006, we recorded net purchases of $344 in short-term investments, as compared to $9,114 in the prior-year period. We also recorded $1,111 in purchases of property, plant and equipment in the current period, a decrease from $2,567 in the first nine months of fiscal 2005. In fiscal 2005, we also used $986 of cash for the purchase of substantially all of the operating assets of Neuroregen, LLC. Financing activities provided $710 of cash during the first nine months of fiscal 2006, all of which are proceeds from stock-based compensation plans. Financing activities provided cash of $766 in the first three quarters of fiscal 2005. 19 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - CONTINUED We have historically funded the operations and investments in our businesses utilizing internally generated cash flow and existing cash balances. We believe existing cash, cash equivalents and short-term investments, coupled with anticipated cash flows from operations, will be sufficient to satisfy our operating cash requirements for the next twelve months. This forward-looking statement, as well as our long-term cash requirements, will be a function of a number of variables, including research and development priorities, acquisition opportunities and the growth and profitability of the business. CRITICAL ACCOUNTING POLICIES Short-term Investments: Our short-term investments consist of high-grade, tax-exempt auction rate securities and municipal bonds. These investments, a portion of which have original maturities beyond one year, are classified as short-term based on their highly liquid nature. The securities which have original maturities beyond one year have certain economic characteristics of short-term investments due to a rate-setting mechanism and the ability to sell them through a Dutch auction process that occurs at pre-determined intervals of less than one year. Our short-term investments are classified as available-for-sale securities and the carrying value of these securities approximates fair market value due to their highly liquid nature. See Note 8 to the unaudited condensed financial statements for additional short-term investment information. Goodwill: In accordance with the Statement of Financial Accounting Standards ("SFAS") No. 142, Goodwill and Other Intangibles Assets, goodwill is not amortized but is reviewed annually for impairment at the end of each fiscal year. See Note 3 to the unaudited consolidated condensed financial statements for additional goodwill information. Other Intangible Assets: Our other intangible assets, primarily developed technology, patents, trademarks, and non-compete agreements pertaining to previous business acquisitions, are recorded at cost and are amortized using the straight-line method over their estimated useful lives, generally three to 17 years. These assets are reviewed for impairment whenever events or changes indicate that the carrying amount of the asset may not be recoverable. See Note 3 to the unaudited consolidated condensed financial statements for additional intangible asset information. Revenue Recognition: Our policy is to ship products to customers on FOB shipping point terms. We recognize revenue when the product has been shipped to the customer if there is evidence that the customer has agreed to purchase the products, delivery and performance have occurred, the price and terms of sale are fixed and collection of the receivable is reasonably assured. All amounts billed to customers in a sales transaction related to shipping and handling are classified as net revenue. Our sales policy does not allow sales returns. Inventories: Inventories, which are comprised of component parts, subassemblies and finished goods, are valued at the lower of first-in, first-out cost or market. Overhead costs are applied to sub-assemblies and finished goods based on annual estimates of production volumes and such costs. These estimates are reviewed and assessed for reasonableness on a quarterly basis and adjusted if so needed. The estimated value of excess, slow-moving and obsolete inventory as well as inventory with a carrying value in excess of its net realizable value is established by us on a quarterly basis through review of inventory on hand and assessment of future product demand, anticipated release of new products into the market, historical experience and product expiration. Derivative Instruments and Hedging Activities: We may enter into derivative instruments or perform hedging activities. However, our policy is to only enter into contracts that can be designated as normal purchases or sales. NEW ACCOUNTING STANDARDS In November 2004, the Financial Accounting Standards Board ("FASB") issued SFAS No. 151, Inventory Costs ("SFAS 151"). This statement amends Chapter 4 of ARB No. 43 to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs and wasted material (spoilage), as well as requiring that allocation of 20 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - CONTINUED fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. The provisions of this statement are effective for inventory costs incurred during fiscal years beginning after June 15, 2005. The Company adopted SFAS 151 on November 1, 2005, which had no effect on its consolidated operating results and financial condition. In December 2004, the FASB issued SFAS No. 123R, Share-Based Payment ("SFAS 123R"). SFAS No. 123R revises SFAS No. 123 and requires entities to recognize compensation expense for all share-based payment transactions in an amount equal to the fair value of share-based payments granted to employees. SFAS No. 123R requires a company to record compensation expense for all awards granted after the date of adoption of SFAS No. 123R and for the unvested portion of previously granted awards that remain outstanding at the date of adoption. SFAS No. 123R was effective for the Company as of November 1, 2005. As of November 1, 2005, only options held by non-employee directors remained unvested and $136 of compensation expense related to the unvested portion of these options was recorded during the nine months ended July 31, 2006. In July 2006, the FASB issued Interpretation No. 48, "Accounting for Uncertainty in Income Taxes-an Interpretation of FASB Statement No. 109," ("FIN 48") which clarifies the accounting for uncertainty in tax positions. This Interpretation requires that the Company recognize in its financial statements the impact of a tax position only if that position is more likely than not of being sustained on audit, based on the technical merits of the position. The provisions of FIN 48 are effective for the Company as of November 1, 2007. The Company is currently in the process of evaluating the impact of the adoption of FIN 48. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The principal financial instruments we maintain are in cash and cash equivalents, short-term investments and accounts receivable. We believe that the interest rate, credit and market risk related to these accounts is not significant. We manage the risk associated with these accounts through periodic reviews of the carrying value for non-collectibility of assets and establishment of appropriate allowances in connection with our internal controls and policies. We may enter into derivative instruments or perform hedging activities. However, our policy is to only enter into contracts that can be designated as normal purchases or sales. ITEM 4 - CONTROLS AND PROCEDURES As of the end of the period covered by this report, we conducted an evaluation, under the supervision and with the participation of our principal executive officer and principal financial officer, of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the "Exchange Act")). Based on this evaluation, the principal executive officer and principal financial officer have concluded that our disclosure controls and procedures are effective and designed to ensure that information required to be disclosed by us in reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms. There have been no changes in our internal controls or in other factors during the fiscal quarter covered by this report which have materially affected, or are reasonably likely to materially affect, and internal controls over financial reporting. 21 PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS In October 2005, one of the third party distributors of our surgical business commenced an arbitration action alleging, among other claims, that we had repudiated the parties' distribution agreement. We have formally disputed the distributor's claims and asserted counterclaims alleging distributor failure to perform under the terms of the contract. The arbitration for this matter is now currently scheduled for January 2007. The Company is unable to evaluate the likelihood of prevailing in these cases at this early stage of the proceedings and have not recorded a liability in our consolidated condensed balance sheet. As of July 31, 2006, the Company had accounts receivable of $449,000 from this distributor pertaining to sales prior to the commencement of the arbitration action. On August 18, 2006, we initiated a patent infringement action in U.S. District Court for the District of Minnesota against Cook Group, Inc., an Indiana-based company. The action alleges infringement of U.S. Patent No. 5,752,965 "Apparatus and Method for Producing a Reinforced Surgical Fastener Suture Line," which covers certain surgical business technology. We intend to vigorously protect our intellectual property, however, there can be no assurances our action will prevail at this early stage. We are also involved in various other legal proceedings which are ordinary routine litigation to our business. While it is impossible to estimate with certainty the ultimate legal and financial liability with respect to this litigation, management is of the opinion that, while the final resolution of any such litigation may have an impact on our consolidated results for a particular reporting period, the ultimate disposition of such litigation will not have any material adverse effect on our financial position, results of operations or liquidity. ITEM 1A. RISK FACTORS No material changes. ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS None. ITEM 3. DEFAULT UPON SENIOR SECURITIES None. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. ITEM 5. OTHER INFORMATION None. ITEM 6. EXHIBITS 4.1 Rights Agreement, dated as of June 1, 2006, between Synovis Life Technologies, Inc. and American Stock Transfer & Trust Company, as Rights Agent, including exhibits thereto (incorporated by reference to Exhibit 4.1 to the Company's Registration Statement on Form 8-A, dated June 1, 2006 (File No. 0-13907)). 31.1 Certification of Chief Executive Officer pursuant to Rule 13a - 14(a) of the Securities Exchange Act of 1934 (filed herewith electronically). 31.2 Certification of Chief Financial Officer pursuant to Rule 13a - 14(a) of the Securities Exchange Act of 1934 (filed herewith electronically). 32.1 Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C Section 1350, as adopted pursuant to Section 906 of the Sarbanes - Oxley Act of 2002 (filed herewith electronically). 22 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized. SYNOVIS LIFE TECHNOLOGIES, INC. Dated: September 7, 2006 /s/ Brett Reynolds ---------------------------------------- Brett Reynolds Vice President of Finance, Chief Financial Officer and Corporate Secretary (Principal Financial Officer) 23 SYNOVIS LIFE TECHNOLOGIES, INC. INDEX TO EXHIBITS 4.1 Rights Agreement, dated as of June 1, 2006, between Synovis Life Technologies, Inc. and American Stock Transfer & Trust Company, as Rights Agent, including exhibits thereto (incorporated by reference to Exhibit 4.1 to the Company's Registration Statement on Form 8-A, dated June 1, 2006 (File No. 0-13907)). 31.1 Certification of Chief Executive Officer pursuant to Rule 13a - 14(a) of the Securities Exchange Act of 1934 (filed herewith electronically). 31.2 Certification of Chief Financial Officer pursuant to Rule 13a - 14(a) of the Securities Exchange Act of 1934 (filed herewith electronically). 32.1 Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C Section 1350, as adopted pursuant to Section 906 of the Sarbanes - Oxley Act of 2002 (filed herewith electronically). 24 EX-31.1 2 c08305exv31w1.txt CERTIFICATION OF CEO PURSUANT TO RULE 13A-14(A) Exhibit 31.1 CERTIFICATIONS PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 Certification of Principal Executive Officer I, Karen Gilles Larson, Chief Executive Officer, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Synovis Life Technologies, Inc. (the "registrant"); 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and we have: a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; c) evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures as of the end of the period covered by this quarterly report based on such evaluation; and d) disclosed in this quarterly report any change in the registrant's internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) that occurred during the registrant's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting. 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls over financial reporting. September 7, 2006 /s/ Karen Gilles Larson ---------------------------------------- Karen Gilles Larson Chief Executive Officer EX-31.2 3 c08305exv31w2.txt CERTIFICATION OF CFO PURSUANT TO RULE 13A-14(A) Exhibit 31.2 CERTIFICATIONS PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 Certification of Principal Financial Officer I, Brett Reynolds, Chief Financial Officer, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Synovis Life Technologies, Inc. (the "Registrant"); 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and we have: a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; c) evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures as of the end of the period covered by this quarterly report based on such evaluation; and d) disclosed in this quarterly report any change in the registrant's internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) that occurred during the registrant's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting. 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls over financial reporting. September 7, 2006 /s/ Brett Reynolds ---------------------------------------- Brett Reynolds Chief Financial Officer EX-32.1 4 c08305exv32w1.txt CERTIFICATION OF CEO & CFO PURSUANT TO 18 U.S.C. SECTION 1350 EXHIBIT 32.1 CERTIFICATIONS UNDER SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 The undersigned officers, Karen Gilles Larson, Chief Executive Officer of Synovis Life Technologies, Inc., a Minnesota Corporation (the "Company"), and Brett Reynolds, Chief Financial Officer of the Company, hereby certify, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: (i) the Quarterly Report on Form 10-Q of the Company for the quarterly period ended July 31, 2006 (the "Report") fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended; and (ii) the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. Date: September 7, 2006 By: /s/ Karen Gilles Larson ------------------------------------ Name: Karen Gilles Larson Title: Chief Executive Officer Date: September 7, 2006 By: /s/ Brett Reynolds ------------------------------------ Name: Brett Reynolds Title: Chief Financial Officer -----END PRIVACY-ENHANCED MESSAGE-----