10-Q 1 s117905_10q.htm 10-Q

  

UNITED STATES 

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

 

FORM 10-Q

 

(Mark One)  

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
   
  For the quarterly period ended March 31, 2019

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: 1-10986

 

 

 

MISONIX, INC. 

(Exact name of registrant as specified in its charter)

 

New York 

(State or other jurisdiction of incorporation or

organization)

11-2148932 

(IRS Employer Identification No.)

 

   

1938 New Highway 

Farmingdale, New York 

(Address of principal executive offices) 

11735 

(Zip code)

 

 

(631) 694-9555 

(Registrant’s telephone number, including area code)

 

Securities registered pursuant to Section 12(b) of the Act:

 

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 ☐ No

 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). ☑ Yes ☐ No

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer ☐ Accelerated filer ☑ Non-accelerated filer ☐ Smaller reporting company ☑
Emerging growth company ☐    

 

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). ☐ Yes ☑ No

 

Title of each class Trading Symbol(s) Name of each exchange on which registered
Common Stock, $.01 par value MSON Nasdaq Global Market

 

Indicate the number of shares outstanding of the issuer’s common stock as of the latest practicable date: As of April 25, 2019, there were 9,641,103 shares of the registrant’s common stock, $0.01 par value, outstanding.

 

1 

 

 

MISONIX, INC.

 

    Page
PART I - FINANCIAL INFORMATION
     
Item 1. Financial Statements   3
     
Condensed Consolidated Balance Sheets at March 31, 2019 (Unaudited) and June 30, 2018   3
     
Condensed Consolidated Statements of Operations for the Three and Nine Months ended March 31, 2019 and 2018 (Unaudited)   4
     
Condensed Consolidated Statement of Shareholders’ Equity for the Three and Nine Months ended March 31, 2019 and 2018 (Unaudited)   5
     
Condensed Consolidated Statements of Cash Flows for the Nine Months ended March 31, 2019 and 2018 (Unaudited)   6
     
Notes to Condensed Consolidated Financial Statements (Unaudited)   7
     
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations   19
     
Item 3. Quantitative and Qualitative Disclosures About Market Risk   24
     
Item 4. Controls and Procedures   24
     
PART II - OTHER INFORMATION
     
Item 1. Legal Proceedings   25
     
Item 1A. Risk Factors   25
     
Item 6. Exhibits   25
     
Signatures   26

 

2 

 

 

PART I - FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

Misonix, Inc. and Subsidiaries

Condensed Consolidated Balance Sheets

 

   March 31,   June 30, 
   2019   2018 
   (Unaudited)      
Assets          
Current assets:          
Cash and cash equivalents  $9,012,220   $10,979,455 
Accounts receivable, less allowance for doubtful accounts of $160,000 and $200,000, respectively   5,333,839    5,245,549 
Inventories, net   6,332,586    5,019,886 
Prepaid expenses and other current assets   864,452    611,647 
Total current assets   21,543,097    21,856,537 
           
Property, plant and equipment, net of accumulated amortization and depreciation of $10,097,703 and $9,023,235, respectively   4,394,548    4,188,378 
Patents, net of accumulated amortization of $1,169,131 and $1,063,393, respectively   779,621    757,447 
Goodwill   1,701,094    1,701,094 
Contract assets   960,000     
Intangible and other assets   433,842    517,295 
Total assets  $29,812,202   $29,020,751 
           
Liabilities and shareholders’ equity          
Current liabilities:          
Accounts payable  $3,521,657   $1,794,098 
Accrued expenses and other current liabilities   2,325,023    2,411,172 
Deferred income   3,995    13,303 
Total current liabilities   5,850,675    4,218,573 
           
Non current liabilities   401,000    401,000 
Total liabilities   6,251,675    4,619,573 
           
Commitments and contingencies          
           
Shareholders’ equity:          
Common stock, $.01 par value-shares authorized 40,000,000; 9,641,103 and 9,430,466 shares issued and outstanding in each period   96,411    94,305 
Additional paid-in capital   43,011,214    39,772,973 
Accumulated deficit   (19,547,098)   (15,466,100)
Total shareholders’ equity   23,560,527    24,401,178 
           
Total liabilities and shareholders’ equity  $29,812,202   $29,020,751 

 

See Accompanying Notes to Consolidated Financial Statements.

 

3 

 

 

Misonix, Inc. and Subsidiaries

Condensed Consolidated Statements of Operations

(Unaudited)

 

   For the three months ended   For the nine months ended 
   March 31,   March 31, 
   2019   2018   2019   2018 
                 
Revenues                    
Product  $9,556,590   $8,429,132   $29,094,208   $24,033,700 
License       4,010,000        4,010,000 
Total revenue   9,556,590    12,439,132    29,094,208    28,043,700 
                     
Cost of goods sold   2,801,571    2,631,893    8,600,194    7,275,073 
Gross profit   6,755,019    9,807,239    20,494,014    20,768,627 
Operating expenses:                    
Selling expenses   4,414,710    4,447,421    13,950,357    11,937,649 
General and administrative expenses   2,512,510    1,925,086    8,043,078    6,879,077 
Research and development expenses   1,426,483    1,199,895    3,570,468    3,058,374 
Total operating expenses   8,353,703    7,572,402    25,563,903    21,875,100 
(Loss) income from operations   (1,598,684)   2,234,837    (5,069,889)   (1,106,473)
                     
Other income (expense):                    
Interest income   22,653    9,074    59,708    9,131 
Royalty income       916        525,438 
Other   (13,650)   (5,712)   (30,817)   (15,474)
Total other income   9,003    4,278    28,891    519,095 
                     
(Loss) income from operations before income taxes   (1,589,681)   2,239,115    (5,040,998)   (587,378)
                     
Income tax expense               5,243,422 
Net (loss) income  $(1,589,681)  $2,239,115   $(5,040,998)  $(5,830,800)
                     
Net (loss) income per share:                    
Basic  $(0.17)  $0.24   $(0.55)  $(0.65)
Diluted  $(0.17)  $0.23   $(0.55)  $(0.65)

 

See Accompanying Notes to Consolidated Financial Statements.

 

4 

 

 

Misonix, Inc. and Subsidiaries

Condensed Consolidated Statement of Shareholders’ Equity

(Unaudited)

 

   Common Stock,             
   $.01 Par Value   Additional       Total 
   Number       paid-in   Accumulated   shareholders’ 
Fiscal Year 2019  of shares   Amount   capital   deficit   equity 
Balance, June 30, 2018   9,430,466   $94,305   $39,772,973   $(15,466,100)  $24,401,178 
Cumulative effect of the adoption of ASC 606 - revenue recognition                  960,000    960,000 
Net loss               (2,610,986)   (2,610,986)
Proceeds from exercise of stock options   51,660    517    415,230        415,747 
Stock-based compensation           1,004,498        1,004,498 
Balance, September 30, 2018   9,482,126    94,822    41,192,701    (17,117,086)   24,170,437 
Net loss               (840,331)   (840,331)
Proceeds from exercise of stock options   102,052    1,020    450,570        451,590 
Stock-based compensation           500,088        500,088 
Balance, December 31, 2018   9,584,178    95,842    42,143,359    (17,957,417)   24,281,784 
Net loss               (1,589,681)   (1,589,681)
Proceeds from exercise of stock options   56,925    569    483,267        483,836 
Stock-based compensation           384,588        384,588 
Balance, March 31, 2019   9,641,103   $96,411   $43,011,214   $(19,547,098)  $23,560,527 

 

   Common Stock,             
   $.01 Par Value   Additional       Total 
   Number       paid-in   Accumulated   shareholders’ 
Fiscal Year 2018  of shares   Amount   capital   deficit   equity 
Balance, June 30, 2017   9,357,166   $93,572   $36,808,810   $(8,762,540)  $28,139,842 
Implementation of new accounting standard                  908,875    908,875 
Net loss               (1,212,224)   (1,212,224)
Proceeds from exercise of stock options   8,500    85    56,117        56,202 
Stock-based compensation           625,293        625,293 
Balance, September 30, 2017   9,365,666    93,657    37,490,220    (9,065,889)   28,517,988 
Net loss               (6,856,774)   (6,856,774)
Proceeds from exercise of stock options   35,000    350    168,000        168,350 
Stock-based compensation           844,601        844,601 
Balance, December 31, 2017   9,400,666    94,007    38,502,821    (15,922,663)   22,674,165 
Net loss               2,238,198    2,238,198 
Proceeds from exercise of stock options   1,800    18    3,653        3,671 
Stock-based compensation           611,127        611,127 
Balance, March 31, 2018   9,402,466   $94,025   $39,117,601   $(13,684,465)  $25,527,161 

 

See Accompanying Notes to Consolidated Financial Statements.

 

5 

 

 

Misonix, Inc. and Subsidiaries

Condensed Consolidated Statements of Cash Flows

(Unaudited)

 

   For the nine months ended 
   March 31, 
Operating activities  2019   2018 
Net loss  $(5,040,998)  $(5,830,800)
Adjustments to reconcile net loss to net cash (used in) provided by operating activities:          
Depreciation and amortization   1,180,206    1,046,511 
Disposals of property, plant and equipment       138,972 
Bad debt expense   69,613     
Deferred income tax expense       5,243,422 
Stock-based compensation   1,889,175    2,081,021 
Deferred lease liability   (9,308)   (7,015)
Changes in operating assets and liabilities:          
Accounts receivable   (157,903)   654,610 
Inventories   (2,004,812)   (1,194,747)
Prepaid expenses and other current assets   (252,805)   (92,987)
Deferred income       5,514 
Intangible and other assets   83,453     
Accounts payable, accrued expenses and other current liabilities   1,641,410    (1,041,513)
Net cash (used in) / provided by operating activities   (2,601,969)   1,002,988 
           
Investing activities          
Acquisition of property, plant and equipment   (588,526)   (358,013)
Additional patents   (127,912)   (120,638)
Net cash used in investing activities   (716,438)   (478,651)
           
Financing activities          
Proceeds from exercise of stock options   1,351,172    228,223 
Net cash provided by financing activities   1,351,172    228,223 
           
Net (decrease) increase in cash and cash equivalents   (1,967,235)   752,560 
Cash and cash equivalents at beginning of period   10,979,455    11,557,071 
Cash and cash equivalents at end of period  $9,012,220   $12,309,631 
           
Supplemental disclosure of cash flow information:          
Cash paid for:          
Income taxes  $71,787   $895 
Transfer of inventory to property, plant and equipmment for consignment of product  $692,112   $1,022,680 
           
Adoption of new accounting standard on deferred taxes  $   $908,875 

 

See Accompanying Notes to Consolidated Financial Statements.

 

6 

 

 

Misonix, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

For the Three and Nine Months Ended March 31, 2019 and 2018 (unaudited)

 

1. Basis of Presentation, Organization and Business and Summary of Significant Accounting Policies

 

Basis of Presentation

 

These condensed consolidated financial statements of Misonix, Inc. (“Misonix” or the “Company”) include the accounts of Misonix and its 100% owned subsidiaries. All significant intercompany balances and transactions have been eliminated.

 

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, these financial statements do not include all the information and footnotes required by U.S. GAAP for complete financial statements. As such, they should be read with reference to the Company’s Annual Report on Form 10-K for the fiscal year ended June 30, 2018, which provides a more complete explanation of the Company’s accounting policies, financial position, operating results, business properties and other matters. In the opinion of management, these financial statements reflect all adjustments considered necessary for a fair statement of interim results.

 

Organization and Business

 

Misonix designs, manufactures and markets minimally invasive therapeutic ultrasonic medical devices. These products are used for precise bone sculpting, removal of soft and hard tumors, and tissue debridement, primarily in the areas of neurosurgery, orthopedic surgery, plastic surgery, wound care and maxillo-facial surgery. In the United States, our products are marketed primarily through a hybrid sales approach. This includes direct sales representatives, managed by regional sales managers, along with independent distributors. Outside the United States, we sell BoneScalpel and SonaStar to specialty distributors who purchase products from us to resell to their clinical customer bases. We sell to all major markets in the Americas, Europe, Middle East, Asia Pacific and Africa. The Company operates as one business segment.

 

Pending Merger with Solsys Medical, LLC

 

On May 2, 2019, the Company announced that it has entered into a definitive agreement with Solsys Medical, LLC (“Solsys”), a privately held regenerative medical company, to acquire Solsys in an all-stock transaction valued at approximately $97 million. The planned acquisition of Solsys is expected to substantially broaden Misonix’s addressable market through wound care solutions that are complementary to its existing products. The transaction has been approved by both the Company’s Board of Directors and the Solsys Board of Managers. After the completion of the transaction, it is expected that Misonix shareholders immediately prior to the closing will own 64% of the combined entity, and Solsys unitholders will own 36%. The completion of the acquisition and the issuance of shares in connection with the proposed transaction is subject to the approval by Misonix shareholders and the completion of the transaction is subject to approval by 55% of Solsys’ Series E unitholders and a majority of its Common unitholders, Series A unitholders, Series B unitholders, Series C unitholders and Series D unitholders, voting as a single class, as well as the satisfaction of certain customary closing conditions. The Company will convene a special shareholder meeting to vote on the transaction. The Company anticipates that the transaction will close in the third quarter of calendar year 2019. Professional fees incurred during the quarter ended March 31, 2019 with respect to this matter were $98,000.

 

High Intensity Focused Ultrasound Technology

 

The Company sold its rights to the high intensity focused ultrasound technology to SonaCare Medical, LLC (“SonaCare”) in May 2010. The Company may receive up to approximately $5.8 million in payment for the sale. SonaCare is obligated to pay the Company 7% of the gross revenues received from its sales of the (i) prostate product in Europe and (ii) kidney and liver products worldwide, until the Company has received payments of $3 million, and thereafter 5% of the gross revenues, up to an aggregate payment of $5.8 million, all subject to a minimum annual royalty of $250,000. No payments were received for the nine months ended March 31, 2019 and 2018. Cumulative royalties paid to the Company through March 31, 2019 were $2,542,579.

 

Major Customers and Concentration of Credit Risk

 

Included in revenues are sales to the Company’s distributor of Bone Scalpel in China of approximately $4 million and $0, for the nine months ended March 31, 2019 and 2018, respectively. Accounts receivable from this customer were $1 million and $0 at March 31, 2019 and June 30, 2018, respectively.

 

Total royalties from Medtronic Minimally Invasive Therapies (“MMIT”) related to its sales of the Company’s ultrasonic cutting and sculpting products, which use high frequency sound waves to coagulate and divide tissue for both open and laparoscopic surgery, were $0 and $524,000 for both the three and nine months ended March 31, 2019 and 2018, respectively. Accounts receivable from MMIT royalties were $0 at March 31, 2019 and June 30, 2018. The license agreement with MMIT expired in August 2018.

 

7 

 

At March 31, 2019 and June 30, 2018, the Company’s accounts receivable with customers outside the United Sates were approximately $2,500,000 and $1,630,000, respectively, $152,000 of which is over 90 days at March 31, 2019.

 

Earnings Per Share

 

Earnings per share (“EPS”) is calculated using the two class method, which allocates earnings among common stock and participating securities to calculate EPS when an entity’s capital structure includes either two or more classes of common stock or common stock and participating securities. Unvested share-based payment awards that contain non-forfeitable rights to dividends or dividend equivalents (whether paid or unpaid) are participating securities. As such, unvested shares of restricted stock of the Company are considered participating securities. The dilutive effect of options and their equivalents (including non-vested stock issued under stock based compensation plans), is computed using the “treasury” method.

 

Basic income per common share is based on the weighted average number of common shares outstanding during the period. Diluted income per common share includes the dilutive effect of potential common shares outstanding. The following table sets forth the reconciliation of weighted average shares outstanding and diluted weighted average shares outstanding:

 

   For the three months ended   For the nine months ended 
   March 31,   March 31, 
   2019   2018   2019   2018 
                 
Basic weighted average shares outstanding   9,390,665    9,028,506    9,245,879    8,999,938 
Dilutive effect of resticted stock awards                    
   (participating securities)       373,200         
                     
Denominator for basic earnings per share   9,390,665    9,401,706    9,245,879    8,999,938 
                     
Dilutive effect of stock options       174,238         
                     
Diluted weighted average shares outstanding   9,390,665    9,575,944    9,245,879    8,999,938 

 

Diluted EPS for the three and nine months ended March 31, 2019 and the nine months ended March 31, 2018 as presented is the same as basic EPS as the inclusion of the effect of common share equivalents then outstanding would be anti-dilutive. Accordingly, excluded from the calculation of diluted EPS are the dilutive effect of options to purchase 484,966 and 0 shares of common stock for the three months ended March 31, 2019 and 2018, respectively, and the dilutive effect of options to purchase 491,212 and 482,093 shares of common stock for the nine months ended March 31, 2019 and 2018, respectively. Also excluded from the calculation of earnings per share for the three and nine months ended March 31, 2019 and 2018 are the unvested restricted stock awards which were issued in December 2016.

 

Recent Accounting Pronouncements

 

In May 2014, the Financial Accounting Standards Board (the “FASB”) issued ASC Update No. 2014-09, Revenue from Contracts with Customers (Topic 606), which was subsequently updated (“ASU 2014-09”). The purpose of the updated standard is to provide enhancements to the quality and consistency of revenue recognition between companies using U.S. GAAP and International Financial Reporting Standards. The new five-step recognition model introduces the core principle of recognizing revenue in an amount that reflects the consideration to which the entity expects to be entitled in exchange for the promised goods or services, which includes additional footnote disclosures to describe the nature, amount, timing and uncertainty of revenue, certain costs and cash flow arising from customers.

 

As amended, ASU 2014-09 requires the Company to use either of the following transition methods: (i) a full retrospective approach reflecting the application of the standard in each prior reporting period with the option to elect certain practical expedients; or (ii) a modified retrospective approach with the cumulative effect of initially adopting ASU 2014-09 recognized at the date of adoption. This standard became effective for the Company on July 1, 2018 and the Company adopted the new pronouncement under the modified retrospective approach.

 

In February 2016, the FASB issued guidance on lease accounting requiring lessees to recognize a right-of-use asset and a lease liability for long-term leases, Accounting Standards Update (“ASU”) 2016-02 – Leases (Topic 842). The liability will be equal to the present value of lease payments. This guidance must be applied using a modified retrospective transition approach to all annual and interim periods presented and is effective for the Company beginning in fiscal 2020. The Company is currently evaluating this guidance to determine the impact it will have on its consolidated financial statements.

 

8 

 

In August 2016, the FASB issued guidance on the Statement of Cash Flows Classification of certain cash receipts and cash payments (a consensus of the Emerging Issues Task Force) ASU 2016-15, Statement of Cash Flows (Topic 230) (“ASU 2016-150”). This guidance addresses the following eight specific cash flow issues: Debt prepayment or debt extinguishment costs; settlement of zero-coupon debt instruments or other debt instruments with coupon interest rates that are insignificant in relation to the effective interest rate of the borrowing; contingent consideration payments made after a business combination; proceeds from the settlement of insurance claims; proceeds from the settlement of corporate-owned life insurance policies (including bank-owned life insurance policies); distributions received from equity method investees; beneficial interests in securitization transactions; and separately identifiable cash flows and application of the predominance principle. This guidance became effective for the Company beginning in fiscal 2019. As this guidance only affects the classification within the statement of cash flows, ASU 2016-15 did not have a material impact on the Company’s consolidated financial statements.

 

In January 2018, the FASB issued ASU No. 2018-01, Business Combinations: Clarifying the Definition of a Business (“ASU 2018-01”). ASU 2018-01 clarifies the definition of a business for determining whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. ASU 2018-01 is effective for annual periods and interim periods within those annual periods beginning after December 15, 2018, and early adoption is permitted. The Company’s adoption of ASU 2018-01 did not have a material effect on the Company’s consolidated financial statements.

 

There are no other recently issued accounting pronouncements that are expected to have a material effect on the Company’s financial position, results of operations or cash flows.

 

Critical Accounting Policies and Use of Estimates

 

Use of Estimates

 

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and judgments that affect the reported amount of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Significant estimates and assumptions are used for but not limited to establishing the allowance for doubtful accounts, valuation of inventory, depreciation, asset impairment evaluations and establishing deferred tax assets and related valuation allowances, and stock-based compensation. Actual results could differ from those estimates.

 

2. Revenue Recognition

 

On July 1, 2018 the Company adopted Accounting Standards Codification (“ASC”) Topic 606 “Revenue from Contracts with Customers, as amended” (“ASC Topic 606”), using the modified retrospective method applied to those contracts which were not completed as of the adoption date. The reported results for the nine months ended March 31, 2019 reflect the application of Topic 606 guidance while the reported results for fiscal year 2018 were prepared under the guidance of ASC Topic 605, “Revenue Recognition”. The adoption of ASC Topic 606 resulted in a cumulative prior period adjustment in the amount of $960,000 related to the Company’s License and Exclusive Manufacturing Agreement described below, but the remainder of the adoption did not have a material impact on the timing or amount of revenue recognized.

 

The impacts of adopting ASC Topic 606 on the Company’s consolidated balance sheets as of July 1, 2018 were as follows:

 

           As 
           Adjusted 
   As   ASC 606   Under 
   Reported   Adjustments   ASC 606 
             
Contract assets  $   $960,000   $960,000 
                
Total Shareholders’ equity  $24,401,178   $960,000   $25,361,178 

 

The Company has made the following accounting policy elections and elected to use certain practical expedients, as permitted by the FASB, in applying ASC Topic 606: 1) the Company accounts for amounts collected from customers for sales and other taxes net of related amounts remitted to tax authorities; 2) the Company expenses costs to obtain a contract as they are incurred if the expected period of benefit, and therefore the amortization period, is one year or less; 3) the Company accounts for shipping and handling activities that occur after control transfers to the customer as a fulfillment cost rather than an additional promised service and these fulfillment costs fall within selling, general and administrative expenses; 4) the Company does not assess whether promised goods or services are performance obligations if they are immaterial in the context of the contract with the customer; 5) the Company will utilize the right-to-invoice practical expedient with regard to the recognition of revenue upon the purchase of consumable goods in connection with a product placement/consignment arrangement.

 

9 

 

The Company determines revenue recognition through the following steps:

 

  Identification of the contract, or contracts, with a customer
  Identification of the performance obligations in the contract
  Determination of the transaction price
  Allocation of the transaction price to the performance obligations in the contract
  Recognition of revenue when, or as, a performance obligation is satisfied

 

Contracts and Performance Obligations

 

The Company accounts for a contract with a customer when there is an approval and commitment from both parties, the rights of the parties are identified, payment terms are identified, the contract has commercial substance and collectability of the consideration is probable. The Company’s performance obligations consist mainly of transferring control of products and related services identified in the contracts, purchase orders or invoices. For each contract, the Company considers the obligation to transfer products or bundled products and services to the customer, of which each is distinct in the context of the contract, to be performance obligations. The Company historically has not made provisions for returns and allowances as they have not been material to the operations of the Company.

 

Transaction Price and Allocation to Performance Obligations

 

Transaction prices of products are typically based upon contracted rates as specified on the purchase order for the purchase of consumables. The Company’s contracted rates represent the standalone selling price of a consumable which is generally determined through the sale of products and/or bundled products or services separately in similar circumstances to similar customers. The Company determines the effects of variable consideration, inclusive of any constraints, in determining the transaction price with regard to its contracts with customers.

 

Recognition of Revenue

 

The Company satisfies performance obligations either over time, or at a point in time, upon which control transfers to the customer.

 

Revenue derived from the shipping and billing of product is recorded upon shipment, when transfer of control occurs for products shipped freight on board (“F.O.B.”) shipping point. Products shipped F.O.B. destination point are recorded as revenue when received at the point of destination when the transfer of control is completed. Shipments under agreements with distributors are not subject to return, and payment for these shipments is not contingent on sales by the distributor. Accordingly, the Company recognizes revenue on shipments to distributors in the same manner as with other customers under the ship and bill process.

 

Revenue derived from the rental of equipment is recorded on a monthly basis over the term of the lease. Shipments of consumable products to these rental customers is recorded as orders are received and shipments are made F.O.B. destination or F.O.B. shipping point.

 

Revenue derived from consignment agreements is earned as consumables product orders are fulfilled. Therefore, revenue is recognized as shipments are made F.O B shipping point or F.O.B destination.

 

Revenue derived from service and maintenance contracts is recognized evenly over the life of the service agreement as the services are performed.

 

Contract Specific Performance Obligations and Significant Judgements

 

Product Placement/Consignment Agreements

 

The Company’s product placement/consignment agreements provide for the placement of a generator at the customer’s place of business and set pricing related to the purchase of consumables for use in conjunction with the generator. These agreements do not require any minimum consumable purchase quantities and do not have a stated term. The Company considers the transaction price in these arrangements to be fully constrained variable consideration because it is dependent on future sales of consumables to the customer. The Company has determined that the pattern of purchase of consumables by a customer is consistent with the benefit received by the customer for the use of the generator and therefore the Company has a right to consideration based upon the pattern of consumable purchases placed through purchase orders by the customer. The Company’s invoices to these customers have short-term payment terms and are aligned with the transfer of goods and services to the customer and the Company recognizes revenue based upon its right to invoice customers.

 

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License and Manufacturing Agreement

 

On October 19, 2018, the Company entered into a License and Exclusive Manufacturing Agreement (the “L&M Agreement”) with Hunan Xing Hang Rui Kang Bio-technologies Co., Ltd, a Chinese corporation (the “Licensee”) under which Misonix has licensed certain manufacturing and distribution rights to its SonaStar product line in China, Hong Kong and Macau. The Licensee was obligated to make an initial payment of $5,000,000 for the transfer of functional intellectual property and initial stocking orders of product. In addition, the Licensee is required to make minimum royalty payments of $2,000,000 per calendar year for three years beginning in 2019, based upon the manufacture of products by the Licensee. The Company collected $5,000,000 of initial revenue for the quarter ended March 31, 2018 under ASC 605. Upon the adoption of ASC Topic 606, the Company evaluated this contract under the provisions of the new revenue standard. The Company determined that the satisfied performance obligations and allocation of the transaction price related to the $5,000,000 received prior to adoption was consistent with the provisions of ASC Topic 606 and also recorded a transitional adjustment to accumulated deficit in the amount of $960,000 as follows:

 

Minimum royalty revenue provided by the contract  $6,000,000 
      
Implicit price concession   (5,040,000)
      
Adoption adjustment to accumulated deficit under ASC Topic 606  $960,000 

 

Although the contract includes minimum royalties, the Company concluded that a significant portion of those guaranteed minimums are actually variable consideration subject to the constraint because the Company has provided an implicit price concession. Specifically, the fact that production of the product in China is not assured and the Licensee must develop a manufacturing process, coupled with the fact that new technology related to the product is expected to be available for sale domestically, may result in the Licensee not earning sufficient revenue in order to pay the minimum royalties. Therefore, the Company has determined variable consideration through utilization of the most likely method based upon forecasts and projections of shipment of products.

 

The Company will monitor facts and circumstances over time and adjust management’s most likely estimate of variable consideration on a quarterly basis.

 

Disaggregation of Revenue

 

The Company generates revenue from the sale and leasing of medical equipment and from the sale of consumable products used with medical equipment in surgical procedures as well as through product licensing arrangements. In the United States, the Company’s products are marketed primarily through a hybrid sales approach which includes direct sales representatives, managed by regional sales managers, along with independent distributors. Outside the United States, the Company sells BoneScalpel and SonaStar to specialty distributors who purchase products to resell to their clinical customer bases. The Company sells to all major markets in the Americas, Europe, Middle East, Asia Pacific, and Africa. Revenue is disaggregated from contracts between products under ship and bill arrangements and licensing agreements, and by geography, which the Company believes best depicts how the nature, amount, timing and uncertainty of revenues and cash flows are affected by economic factors. The Company also provides an immaterial amount of service revenue which is recognized over time, but not stated separately because the amounts are immaterial.

 

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The following table disaggregates the Company’s product revenue by classification and geographic location: 

 

   For the three months ended   For the nine months ended 
   March 31,  March 31,
   2019   2018   2019   2018 
Total                
Consumables  $6,870,398   $5,898,937   $20,785,446   $17,404,539 
Equipment   2,686,192    2,530,195    8,308,762    6,629,161 
Total Product   9,556,590    8,429,132    29,094,208    24,033,700 
License       4,010,000        4,010,000 
Total  $9,556,590   $12,439,132   $29,094,208   $28,043,700 
                     
Domestic:                    
Consumables  $4,862,308   $4,340,759   $15,170,476   $13,063,171 
Equipment   547,470    590,269    1,727,181    1,920,424 
Total  $5,409,778   $4,931,028   $16,897,657   $14,983,595 
                     
International:                    
Consumables  $2,008,090   $1,558,178   $5,614,970   $4,341,368 
Equipment   2,138,722    1,939,926    6,581,581    4,708,737 
Total  $4,146,812   $3,498,104   $12,196,551   $9,050,105 
                     
License  $   $4,010,000   $   $4,010,000 

 

Contract Assets

 

The timing of revenue recognition, customer invoicing, and collections produces accounts receivable and contract assets on the Company’s consolidated balance sheet. Contract liabilities are not material to the operations of the Company as of March 31, 2019. The Company invoices in accordance with contract payment terms. Invoices to customers represent an unconditional right of the Company to receive consideration. When revenue is recognized in advance of customer invoicing a contract asset is recorded. Unpaid customer invoices are reflected as accounts receivable.

 

The Company has established a contract asset in conjunction with the Company’s L&M Agreement based upon its assessment of the most likely variable consideration to be received by the Company as a result of the royalty provisions in the contract. The asset is recorded as a long-term asset as the Company believes that payment will be made on this asset in a duration exceeding one year. Contract assets as of March 31, 2019 and June 30, 2018 were $960,000 and $0, respectively.

 

Selling Costs

 

Incremental direct costs of obtaining a sales contract primarily include sales commissions paid to sales personnel and outside sales representatives in connection with sales of products under ship and bill scenarios or through product placement scenarios. The expected period of benefit of these costs is one year or less and therefore the Company has elected the practical expedient to expense such costs in the period in which they are incurred. Typically, costs in fulfilling a contract represent shipping and handling costs and the Company accounts for these costs as fulfillment costs and they are expensed as incurred. Costs in fulfilling a contract are only capitalized as an asset if they relate directly to an existing contract or specific anticipated contract, they generate or enhance resources of the entity that will be used to satisfy performance obligations in the future, and they are expected to be recovered. The Company has not identified any such costs.

 

3. Fair Value of Financial Instruments

 

The Company follows a three-level fair value hierarchy that prioritizes the inputs to measure fair value. This hierarchy requires entities to maximize the use of “observable inputs” and minimize the use of “unobservable inputs.” The three levels of inputs used to measure fair value are as follows:

 

Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets as of the measurement date.

 

Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.

 

Level 3: Significant unobservable inputs that reflect assumptions that market participants would use in pricing an asset or liability.

 

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At March 31, 2019 and June 30, 2018, all of the Company’s cash and cash equivalents, trade accounts receivable and trade accounts payable were short term in nature, and their carrying amounts approximate fair value.

 

4. Inventories

 

Inventories are summarized as follows:

 

   March 31,   June 30, 
   2019   2018 
Raw material  $3,698,319   $3,540,205 
Work-in-process   323,650    180,442 
Finished goods   2,754,875    1,743,497 
    6,776,844    5,464,144 
Less valuation reserve   (444,258)   (444,258)
   $6,332,586   $5,019,886 

 

5. Property, Plant and Equipment

 

Depreciation and amortization of property, plant and equipment was $1,074,000 and $953,000 for the nine months ended March 31, 2019 and 2018, respectively. Inventory items included in property, plant and equipment are depreciated using the straight line method over estimated useful lives of 3 to 5 years. Depreciation of generators which are consigned to customers is expensed over a 5-year period, and depreciation is charged to selling expenses.

 

6. Goodwill

 

The excess of the cost over the fair value of net assets of acquired businesses is recorded as goodwill. Goodwill is not subject to amortization, but is reviewed for impairment at the reporting unit level annually, or more frequently if impairment indicators arise. The Company’s assessment of the recoverability of goodwill is based upon a comparison of the carrying value of goodwill with its estimated fair value and the value of the Company at the measurement date.

 

Application of these impairment tests requires significant judgments, including estimation of cash flows, which is dependent on internal forecasts, estimation of the long term rate of growth for the Company’s business, the useful lives over which cash flows will occur and determination of the Company’s weighted average cost of capital. The Company’s market capitalization exceeds the value of the goodwill. The Company concluded that there was no impairment to goodwill at June 30, 2018 and June 30, 2017. There were no triggering events identified during the quarter ended March 31, 2019.

 

7. Patents

 

The costs of acquiring or processing patents are capitalized at cost. These amounts are being amortized using the straight-line method over the estimated useful lives of the underlying assets, which is approximately 17 years. Patents, net of accumulated amortization, totaled $779,621 and $757,447 at March 31, 2019 and June 30, 2018, respectively. Amortization expense for the nine months ended March 31, 2019 and 2018 was $106,000 and $94,000, respectively. The following is a schedule of estimated future patent amortization expenses by fiscal year as of March 31, 2019:

 

2019   $34,998 
2020    117,217 
2021    110,025 
2022    72,364 
2023    71,273 
Thereafter    373,744 
    $779,621 

 

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8. Accrued Expenses and Other Current Liabilities

 

The following summarizes accrued expenses and other current liabilities:

 

   March 31,   June 30, 
   2019   2018 
         
Accrued payroll, payroll taxes and vacation  $443,623   $351,435 
Accrued bonus   450,144    552,988 
Accrued commissions   698,534    742,807 
Professional fees   167,240    102,065 
Vendor, tax and other accruals   565,482    661,877 
           
   $2,325,023   $2,411,172 

 

9. Stock-Based Compensation Plans

 

Stock Option Awards

 

For the nine months ended March 31, 2019 and 2018, the compensation cost relating to stock option awards that has been charged against income for the Company’s stock option plans was $896,730 and $1,405,152, respectively. As of March 31, 2019, there was $2,965,772 of total unrecognized compensation cost related to non-vested share-based compensation arrangements to be recognized over a weighted-average period of 2.9 years.

 

Stock options typically expire 10 years from the date of grant and vest over service periods, which typically are 4 years. All options are granted at fair market value, as defined in the applicable plans.

 

The fair value of each option award was estimated on the date of grant using the Black-Scholes option valuation model that uses the assumptions noted in the following table. The expected volatility represents the historical price changes of the Company’s stock over a period equal to that of the expected term of the option. The Company uses the simplified method for determining the option term. The risk-free rate was based on the U.S. Treasury yield curve in effect at the time of grant. The expected dividend yield is based upon historical and projected dividends. The Company has historically not paid dividends, and is not expected to do so in the near term.

 

The weighted average fair value per share at date of grant for options granted during the nine months ended March 31, 2019 was $9.22. There were options to purchase 255,000 and 305,500 shares granted during the nine months ended March 31, 2019 and 2018, respectively. The fair value was estimated based on the weighted average assumptions of:

 

   For nine months ended 
   March 31, 2019 
   2019   2018 
Risk-free interest rates   2.80%   1.98%
Expected option life in years   6.25    5.95 
Expected stock price volatility   56.01%   57.42%
Expected dividend yield   0%   0%

 

A summary of option activity under the Company’s equity plans as of March 31, 2019, and changes during the nine months ended March 31, 2019 is presented below:

 

  

Outstanding

Shares

  

Average

Exercise

Price

   Aggregate Intrinsic Value 
Outstanding at June 30, 2018   1,330,193  $8.47  $5,369,557 
Granted   255,000    16.64      
Exercised   (240,210)   7.97      
Forfeited   (159,252)   10.18      
Expired   (15,000)   2.66      
Outstanding as of March 31, 2019   1,170,731   $10.27   $10,530,733 
Vested and exercisable at March 31, 2019   642,355   $8.28   $7,034,104 

 

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The total fair value of stock options vested during the nine months ended March 31, 2019 was $1,101,971. The number and weighted-average grant-date fair value of non-vested stock options at the beginning of fiscal 2018 was 648,877 and $5.08, respectively. The number and weighted-average grant-date fair value of stock options which vested during the nine months ended March 31, 2019 was 220,624 and $4.99, respectively.

 

Restricted Stock Awards

 

On December 15, 2016, the Company issued 400,000 shares of restricted stock to its Chief Executive Officer. These awards vest over a period of up to five years, subject to meeting certain service, performance and market conditions. These awards were valued at approximately $3.6 million. Compensation expense recorded in the nine months ended March 31, 2019 and 2018 related to these awards was $992,445 and $675,869 respectively. As of March 31, 2019, there was approximately $1,256,204 of total unrecognized compensation cost related to non-vested restricted stock awards to be recognized over a weighted-average period of 2.82 years. The awards contain a combination of vesting terms which include time vesting, performance vesting relating to revenue achievement, and market vesting related to obtaining certain levels of Company stock prices. At March 31, 2019, the Company has estimated that it is probable that the performance conditions will be met. The awards were valued using a Monte Carlo valuation model using a stock price at the date of grant of $9.60, a term of 3 to 5 years, a risk free interest rate of 1.6% to 2.1% and a volatility factor of 66.5%. As of March 31, 2019, 186,600 shares from this set of awards have vested.

 

During the nine months ended March 31, 2019, the performance conditions of one of these restricted stock awards were met, resulting in the full amortization of this award during the period, totaling $475,286 of additional amortization during the first quarter of the current fiscal year. The number of restricted stock awards which vested was 133,333.

 

10. Commitments and Contingencies

 

Leases

 

The Company has entered into several non-cancellable operating leases for the rental of certain manufacturing and office space, equipment and automobiles expiring in various years through 2021. The principal building lease provides for a monthly rental of approximately $28,000.

 

Class Action Securities Litigation

 

On September 19, 2016, Richard Scalfani, an individual shareholder of Misonix, filed a lawsuit against the Company and its former chief executive officer and chief financial officer in the U.S. District Court for the Eastern District of New York, alleging violations of the federal securities laws. The complaint alleges that the Company’s stock price was artificially inflated between November 5, 2015 and September 14, 2016 as a result of alleged false and misleading statements in the Company’s securities filings concerning the Company’s business, operations, and prospects and the Company’s internal control over financial reporting. Scalfani filed the action seeking to represent a putative class of all persons (other than defendants, officers and directors of the Company, and their affiliates) who purchased publicly traded Misonix securities between November 5, 2015 and September 14, 2016. Scalfani was seeking an unspecified amount of damages for himself and for the putative class under the federal securities laws. On March 24, 2017, the Court appointed Scalfani and another individual Misonix shareholder, Tracey Angiuoli, as lead plaintiffs for purposes of pursuing the action on behalf of the putative class. The lead plaintiffs, on behalf of the putative class, and the Company reached a settlement in principle under which the Company would pay $500,000 to resolve the matter. The district court approved the settlement and dismissed the lawsuit with prejudice in an order dated December 16, 2017. The Company has paid its $250,000, representing its insurance retention. The balance was paid by the Company’s insurance carrier.

 

Former Chinese Distributor - FCPA

 

With the assistance of outside counsel, the Company conducted a voluntary investigation into the business practices of the independent Chinese entity that previously distributed the Company’s products in China and the Company’s knowledge of those business practices, which may have had implications under the FCPA, as well as into various internal controls issues identified during the investigation (the “Investigation”). On September 27, 2016 and September 28, 2016, the Company voluntarily contacted the SEC and the DOJ, respectively, to advise both agencies of these potential issues. The Company has provided and will continue to provide documents and information to the SEC and the DOJ, if requested, and is cooperating fully with these agencies in their investigations of these matters. Although the Company’s Investigation is complete, additional issues or facts could arise which may expand the scope or severity of the potential violations. The Company has no current information derived from the Investigation or otherwise to suggest that its previously reported financial statements and results are incorrect.

 

At this stage, the Company is unable to predict what, if any, action the DOJ or the SEC may take or what, if any, penalties or remedial measures these agencies may seek. Nor can the Company predict the impact on the Company as a result of these matters, which may include the imposition of fines, civil and criminal penalties, which are not currently estimable, as well as equitable remedies, including disgorgement of any profits earned from improper conduct and injunctive relief, limitations on the Company’s conduct, and the imposition of a compliance monitor. The DOJ and the SEC periodically have based the amount of a penalty or disgorgement in connection with an FCPA action, at least in part, on the amount of profits that a company obtained from the business in which the violations of the FCPA occurred. During its distributorship relationship with the prior Chinese distributor from 2010 through 2016, the Company generated revenues of approximately $8 million.

 

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Further, the Company may suffer other civil penalties or adverse impacts, including lawsuits by private litigants in addition to the lawsuits that already have been filed, or investigations and fines imposed by local authorities. The investigative costs to date, including costs of litigation relating to the Company’s former Chinese distributor as described below, are approximately $3.7 million, of which approximately $0.2 million and $0.6 million was charged to general and administrative expenses during the three and nine months ended March 31, 2019, respectively, compared with $0.1 million and $0.3 million for the three and nine months ended March 31, 2018.

 

Former Chinese Distributor - Litigation

 

On April 5, 2018, the Company’s former distributor in China, Cicel (Beijing) Science & Technology Co., Ltd., filed a lawsuit against the Company and certain officers and directors of the Company in the United States District Court for the Eastern District of New York, alleging that the Company improperly terminated its contract with the former distributor. The complaint sought various remedies, including compensatory and punitive damages, specific performance and preliminary and post judgment injunctive relief, and asserted various causes of action, including breach of contract, unfair competition, tortious interference with contract, fraudulent inducement, and conversion. On October 7, 2018, the court granted the Company’s motion to dismiss all of the tort claims asserted against it, and also granted the individual defendants’ motion to dismiss all claims asserted against them. The only claim currently remaining in the case is for breach of contract against the Company; the plaintiff has moved to amend its complaint to add tort claims, which the Company intends to oppose. The Company believes it has various legal and factual defenses to the allegations in the complaint, and intends to vigorously defend the action. Fact discovery in the case is currently scheduled to end on May 31, 2019, and there is no trial date currently set.  

 

Stockholder Derivative Litigation

 

On June 6, 2017, Irving Feldbaum, an individual shareholder of Misonix, filed a lawsuit in the U.S. District Court for the Eastern District of New York. The complaint alleges claims against the Company's board of directors, its former chief executive officer and chief financial officer, certain of its former directors, and the Company as a nominal defendant for alleged violations of Section 14(a) of the Securities Exchange Act of 1934 and state law claims for breach of fiduciary duty, waste of corporate assets, and unjust enrichment. The complaint alleges that the Company incurred damages as a result of alleged false and misleading statements in the Company's securities filings concerning the Company's business, operations, and prospects and the Company's internal control over financial reporting. The complaint also alleges that the Company's February 4, 2016 Proxy Statement contained false and misleading statements regarding executive compensation. The complaint seeks the recovery of damages on behalf of the Company and the implementation of changes to corporate governance procedures. On June 16, 2017, Michael Rubin, another individual shareholder of Misonix, filed a case alleging similar claims in the same district court. On July 21, 2017, the district court consolidated the two actions for all purposes. On July 16, 2018, counsel for the Company and counsel for Mr. Feldbaum and Mr. Rubin informed the District Court that the parties had reached a settlement in principle. On May 7, counsel for Mr. Feldbaum and Mr. Rubin filed a motion for preliminary approval of the settlement, to which the executed settlement agreement is an exhibit.  The Company has agreed to certain corporate governance reforms in resolving the case and to pay counsel for Mr. Feldbaum and Mr. Rubin an attorneys fee of $500,000 which is expected to be covered by Misonix’s insurance carrier.  If the court preliminarily approves the settlement, the settlement will remain subject to the district court's final approval. 

 

11. Related Party Transactions

 

OrthoXact Proprietary Limited (“OrthoXact”) (formerly Applied BioSurgical) is an independent distributor for the Company in South Africa. The chief executive officer of OrthoXact is also the brother of Stavros G. Vizirgianakis, the Company’s chief executive officer.

 

Sales to OrthoXact for the nine months ended March 31, 2019 and 2018 were $996,631 and $675,943, respectively. Accounts receivable at March 31, 2019 and June 30, 2019 were $286,852 and $120,376, respectively.

 

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12. Income Taxes

 

For the three and nine months ended March 31, 2019 and 2018, the Company recorded income tax expense (benefit), as follows:

 

   For the three months ended   For the nine months ended 
   March 31,   March 31, 
   2019   2018   2019   2018 
                 
Income tax expense (benefit)  $(509,000)  $411,405   $(1,164,000)  $(97,744)
Reduction of deferred tax assets relating to Tax Legislation                1,764,039 
Valuation allowance on deferred tax assets   509,000    (411,405)   1,164,000    3,577,127 
                     
Net income tax expense  $   $   $   $5,243,422 

 

For the nine months ended March 31, 2019 and 2018, the effective rate of 0% and (892.7%), respectively, varied from the U.S. federal statutory rate primarily due to the recording of a full valuation allowance on the remaining deferred tax assets, permanent book tax differences relating principally to stock compensation expense and tax credits, and the impact of the Tax Cuts and Jobs Act of 2018.

 

Tax Cuts and Jobs Act of 2017

 

The Tax Cuts and Jobs Act of 2017, enacted on December 22, 2017, contains significant changes to U.S. tax law, including lowering the U.S. corporate income tax rate to 21%, implementing a territorial tax system, and imposing a one-time tax on deemed repatriated earnings of foreign subsidiaries.

 

Valuation Allowance on Deferred Tax Assets

 

Deferred tax assets refer to assets that are attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets in essence represent future savings of taxes that would otherwise be paid in cash. The realization of the deferred tax assets is dependent upon the generation of sufficient future taxable income, including capital gains. If it is determined that the deferred tax assets cannot be realized, a valuation allowance must be established, with a corresponding charge to net income.

 

In accordance with ASC Topic 740, the Company establishes valuation allowances for deferred tax assets that, in its judgment are not more likely-than-not realizable. The guidance requires entities to evaluate all available positive and negative evidence, including cumulative results in recent periods, weighted based on its objectivity, in determining whether its deferred tax assets are more likely than not realizable.

 

The Company regularly assesses its ability to realize its deferred tax assets. While the Company had positive cumulative pretax income as of June 30, 2018, based on actual results for fiscal 2018 and the Company’s current forecast for fiscal 2019 the Company is in a three-year cumulative loss position at March 31, 2019, and it expects to be in a cumulative pretax loss position as of June 30, 2019. Management evaluated available positive evidence, including the continued growth of the Company’s revenues and gross profit margins, its recent SonaStar technology license to its Chinese partner and the reduction in investigative and professional fees recognized in fiscal 2018, along with available negative evidence, including the Company’s continuing investment in building its next generation Nexus platform and its continuing investment in building a direct sales force, while at the same time paying commissions to its domestic sales distributors. After weighing both the positive and negative evidence, management concluded that the Company’s deferred tax assets are not more likely-than-not realizable. Accordingly, the Company recorded a full valuation allowance against its deferred tax assets. The Company will continue to assess its ability to utilize its net operating loss carryforwards, and will reverse this valuation allowance when sufficient evidence is achieved to allow the realizability of such deferred tax assets.

 

As of March 31, 2019 and June 30, 2018, the Company had no material unrecognized tax benefits or accrued interest and penalties.

 

13. Segment Reporting

 

Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated on a regular basis by the chief operating decision-maker (“CODM”) in deciding how to allocate resources to an individual segment and in assessing performance of the segment. The Company has concluded that its Chief Executive Officer is the CODM as he is the ultimate decision maker for key operating decisions, determining the allocation of resources and assessing the financial performance of the Company. These decisions, allocations and assessments are performed by the CODM using consolidated financial information. Consolidated financial information is utilized by the CODM as the Company’s current product offering primarily consists of minimally invasive therapeutic ultrasonic medical devices. The Company’s products are relatively consistent and manufacturing is centralized and consistent across product offerings. Based on these factors, key operating decisions and resource allocations are made by the CODM using consolidated financial data and as such the Company has concluded that it operates as one segment.

 

17

 

 

Worldwide revenue for the Company’s products and license revenue is categorized as follows:

 

   For the three months ended   For the nine months ended 
   March 31,   March 31, 
   2019   2018   2019   2018 
                 
Product revenue:                    
Domestic  $5,409,778   $4,931,028   $16,897,657   $14,983,595 
International   4,146,812    3,498,104    12,196,551    9,050,105 
Total   9,556,590    8,429,132    29,094,208    24,033,700 
                     
License revenue       4,010,000        4,010,000 
                     
Total revenue  $9,556,590   $12,439,132   $29,094,208   $28,043,700 

 

Substantially all of the Company’s long-lived assets are located in the United States.

 

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

This Management’s Discussion and Analysis of Financial Condition and Results of Operations of Misonix and its subsidiaries, which we refer to as the “Company”, “Misonix”, “we”, “our” and “us”, should be read in conjunction with the accompanying unaudited financial statements included in Part I - Item 1 “Financial Statements” of this Report and Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K, filed with the Securities and Exchange Commission (the “SEC”) on September 13, 2018, for the fiscal year ended June 30, 2018 (“2018 Form 10-K”). Item 7 of the 2018 Form 10-K describes the application of our critical accounting policies, for which there have been no significant changes during the nine months ended March 31, 2019.

 

Forward Looking Statements

 

With the exception of historical information contained in this Form 10-Q, content herein may contain “forward looking statements” that are made pursuant to the Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995. These statements are based on management’s current expectations and are subject to uncertainty and changes in circumstances. We cannot guarantee that any forward looking statements will be accurate, although we believe that we have been reasonable in our expectations and assumptions. Investors should realize that if underlying assumptions prove inaccurate or unknown risks or uncertainties materialize, actual results could vary materially from our expectations and projections. These factors include general economic conditions, delays and risks associated with the performance of contracts, risks associated with international sales and currency fluctuations, uncertainties as a result of research and development, acceptable results from clinical studies, including publication of results and patient/procedure data with varying levels of statistical relevance, risks involved in introducing and marketing new products, regulatory compliance, potential acquisitions, the ability to complete the pending transaction with Solsys on the terms and within the timeframe, and on the financing terms, currently contemplated, any material regulatory or other unexpected requirements in connection therewith, consumer and industry acceptance, litigation and/or contemplated 510(k) filings, the ability to achieve and maintain profitability in our business lines, the pending FCPA investigation and other factors discussed in the 2018 Form 10-K, subsequent Quarterly Reports on Form 10-Q and Current Reports on Form 8-K. We disclaim any obligation to update any forward-looking statements.

 

Overview

 

Misonix designs, manufactures and markets minimally invasive therapeutic ultrasonic medical devices. These products are used for precise bone sculpting, removal of soft and hard tumors, and tissue debridement, primarily in the areas of neurosurgery, orthopedic surgery, plastic surgery, wound care and maxillo-facial surgery. In the United States, the Company sells its products through its direct sales force, in addition to a network of commissioned agents assisted by Company personnel. Outside of the United States, the Company generally sells to distributors who then resell the products to hospitals. The Company operates as one business segment.

 

In the United States, the Company is taking a more aggressive approach to taking market share, expanding the market and increasing its share of recurring disposable revenue by using a consignment model, whereby the Company will consign the equipment (which is defined as a generator, hand units and accessories) (the “Equipment”) and sell to customers higher margin disposable, single use items (the “Consumables”) on a recurring basis. Title remains with the Company with respect to consigned Equipment, which is depreciated and charged to selling expenses over a five-year period. The Company’s overall goal is to increase the utilization rate of Equipment which will increase the total number of procedures and maximize the sale of Consumables to our customers, with the goal of becoming the standard of care in the medical procedures on which we focus.

 

Pending Acquisition of Solsys Medical, LLC

 

On May 2, 2019, the Company announced that it has entered into a definitive agreement with Solsys Medical, LLC (“Solsys”), a privately held regenerative medical company, to acquire Solsys in an all-stock transaction valued at approximately $97 million. The planned acquisition of Solsys is expected to substantially broaden Misonix’s addressable market through wound care solutions that are complementary to its existing products. Under the terms of the agreement, a new holding company will issue approximately 5.7 million new shares of common stock to Solsys unitholders and current Misonix shareholders will have their shares of the Company’s common stock converted into shares of the holding company’s common stock on a one-for-one basis. After the completion of the transaction, it is expected that Misonix shareholders immediately prior to the closing will own 64% of the holding company, and Solsys unitholders will own 36%. Misonix will also assume Solsys’ outstanding secured debt, with an expected balance of approximately $20 million, upon closing. In addition, the holding company’s Board of Directors will consist of five members: three current Misonix directors, including Stavros Vizirgianakis, and two directors nominated by Solsys at closing.

 

The transaction has been approved by both the Company’s Board of Directors and the Solsys Board of Managers. The completion of the acquisition and the issuance of the holding company’s shares in connection with the proposed transaction is subject to the approval by Misonix shareholders and the completion of the transaction is subject to approval by 55% of Solsys’ Series E unitholders and a majority of its Common unitholders, Series A unitholders, Series B unitholders, Series C unitholders and Series D unitholders, voting as a single class, as well as the satisfaction of certain customary closing conditions. The Company will convene a special shareholder meeting to vote on the transaction. the Company anticipates that the transaction will close in the third quarter of calendar 2019.

 

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Results of Operations

 

The following discussion and analysis provides information which the Company’s management believes is relevant to an assessment and understanding of the Company’s results of operations and financial condition. This discussion should be read in conjunction with the consolidated financial statements and notes thereto appearing elsewhere herein. Unless otherwise specified, this discussion relates solely to the Company’s operations.

 

All of the Company’s revenues have been derived from the sale of medical device products, which include manufacture and distribution of ultrasonic medical device products, licensing and related services.

 

Three months ended March 31, 2019 and 2018

 

The Company’s revenues by category for the three months ended March 31, 2019 and 2018 are as follows:

 

   For the three months ended         
   March 31,   Net change 
   2019   2018   $   % 
Total                
Consumables  $6,870,398   $5,898,937   $971,461    16.5%
Equipment   2,686,192    2,530,195    155,997    6.2%
Total Product   9,556,590    8,429,132    1,127,458    13.4%
License      4,010,000    (4,010,000)   -100.0%
Total  $9,556,590   $12,439,132   $(2,882,542)   -23.2%
                     
Domestic:                    
Consumables  $4,862,308   $4,340,759   $521,549    12.0%
Equipment   547,470    590,269    (42,799)   -7.3%
Total  $5,409,778   $4,931,028   $478,750    9.7%
                     
International:                    
Consumables  $2,008,090   $1,558,178   $449,912    28.9%
Equipment   2,138,722    1,939,926    198,796    10.2%
Total  $4,146,812   $3,498,104   $648,708    18.5%
                     
License  $   $4,010,000   $(4,010,000)   100.0%

 

Revenues

 

Total revenue decreased 23.2% in the third quarter of fiscal 2019, resulting from $4 million of license revenue being recorded in the third quarter of fiscal 2018, with no corresponding license revenue in the third quarter of fiscal 2019. Product revenue (consumables and equipment) increased 13.4% or $1.1 million to $9.6 million in the third quarter of fiscal 2019, from $8.4 million in the third quarter of fiscal 2018. The largest portion of the product revenue increase was due to the continued growth of consumables in the domestic and international markets as expected. Domestic sales of BoneScalpel and SonicOne were strong, and the exceptional growth in the wound franchise continued.

 

Domestic equipment revenues were below expectations, with customers waiting for the Company’s next generation platform product, Nexus, while international revenues were above expectations with continued momentum in key markets. Nexus is expected to become available in mid-2019, subject to approval by the FDA of the Company’s 510(k) application.

 

The total product revenue increase is principally attributable to a 16.5% or $1.0 million increase in consumables revenue, in addition to a 6.2% or $0.2 million increase in equipment revenue.

 

Gross profit

 

Gross profit from product revenue in the third quarter of fiscal 2019 was 70.7% of revenue, compared with the gross profit margin of 68.8% in the third quarter of fiscal 2018. The increase is the result of product mix with a higher percentage of consumables revenue in the current year, along with the impact of routine manufacturing cost variances.

 

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Selling expenses

 

Selling expenses for the third quarter of fiscal 2019 remained flat with those of the prior year quarter, at $4.4 million. While the Company continues to incur higher compensation costs and travel related expenses resulting from the continued buildout of the Company’s direct sales force, those costs are being offset by lower commissions to distributors in the US, whose contracts are being terminated as the new direct sales force takes over territories.

 

General and administrative expenses

 

General and administrative expenses were $2.5 million in the third quarter of fiscal 2019, an increase of 31% or $0.6 million over the third quarter of fiscal 2018. The increase is principally related to legal and professional fees including those associated with the Company’s ongoing litigation and the SolSys merger.

 

Research and development expenses

 

Research and development expenses increased by $0.2 million or 19% to $1.4 million in the third quarter of fiscal 2019 from $1.2 million in the prior year period. The Company is investing in the design and development of its next generation platform product, Nexus. During the third quarter of fiscal 2019 and fiscal 2018, approximately $0.7 million and $0.8 million, respectively, was charged to research and development expenses related to this product.

 

Other income (expense)

 

Other income was $9,003 in the third quarter of fiscal 2019 compared with $4,278 in the prior year period.

 

Income taxes

 

For the three months ended March 31, 2019 and 2018, the Company did not record tax expense, given that it was in a full valuation allowance position during those periods.

 

Income tax expense for the quarter ended March 31, 2019 includes a $509,000 valuation allowance against the Company’s deferred tax assets recorded in the quarter. In accordance with the guidance of ASC Topic 740, management concluded that in its judgment, the Company’s deferred tax assets at March 31, 2019 are not more likely-than-not realizable. The components of the tax provision are as follows:

 

   For the three months ended 
   March 31, 
   2019   2018 
         
Income tax expense (benefit)  $(509,000)  $411,405 

Reduction of deferred tax assets  relating to Tax Legislation

         
Valuation allowance on deferred tax assets   509,000    (411,405)
           
Net income tax expense  $   $ 

 

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Nine months ended March 31, 2019 and 2018

 

The Company’s revenues by category for the nine months ended March 31, 2019 and 2018 are as follows:

 

   For the nine months ended         
   March 31,   Net change 
   2019   2018   $   % 
Total                
Consumables  $20,785,446   $17,404,539   $3,380,907    19.4%
Equipment   8,308,762    6,629,161    1,679,601    25.3%
Total Product   29,094,208    24,033,700    5,060,508    21.1%
License       4,010,000    (4,010,000)   -100.0%
Total  $29,094,208   $28,043,700   $1,050,508    3.7%
                     
Domestic:                    
Consumables  $15,170,476   $13,063,171   $2,107,305    16.1%
Equipment   1,727,181    1,920,424    (193,243)   -10.1%
Total  $16,897,657   $14,983,595   $1,914,062    12.8%
                     
International:                    
Consumables  $5,614,970   $4,341,368   $1,273,602    29.3%
Equipment   6,581,581    4,708,737    1,872,844    39.8%
Total  $12,196,551   $9,050,105   $3,146,446    34.8%
                     
License  $   $4,010,000   $(4,010,000)   100.0%

 

Revenues

 

Total revenue increased 3.7% during the first three quarters of fiscal 2019, with the growth rate impacted by the $4 million of license revenue being recorded in fiscal 2018, with no corresponding license revenue in fiscal 2019. Product revenue increased 21.1% or $5.0 million to $29.1 million during the first three quarters of fiscal 2019, from $24.0 million in the prior year period. The largest portion of the revenue increase was due to the continued growth of consumables in the domestic and international markets as expected. Domestic sales of BoneScalpel and SonicOne were strong, and the exceptional growth in the wound franchise continued.

 

Domestic equipment revenues were below expectations, with customers waiting for the Company’s next generation platform product, Nexus, while international revenues were above expectations with continued momentum in key markets. Nexus is expected to become available in mid-2019, subject to approval by the FDA of the Company’s 510(k) application.

 

The revenue increase is principally attributable to a 19.4% or $3.4 million increase in consumables revenue, in addition to a 25.3% or $1.7 million increase in equipment revenue.

 

Gross profit

 

Gross profit from product revenue in fiscal 2019 was 70.4% of revenue, compared with the gross profit margin of 69.7% in fiscal 2018. The increase is the result of product mix with a higher percentage of consumables revenue in the current year, along with the impact of routine manufacturing cost variances.

 

Selling expenses

 

Selling expenses increased by $2.0 million, or 16.9% to $14.0 million in the first three quarters of fiscal 2019 from $11.9 million in the prior year period. While the Company continues to incur higher compensation costs and travel related expenses resulting from the continued buildout of the Company’s direct sales force, those costs are being offset by lower commissions to distributors in the US, whose contracts are being terminated as the new direct sales force takes over territories. Higher costs were also incurred for marketing activities and depreciation expense on consigned equipment.

 

General and administrative expenses

 

General and administrative expenses increased by $1.2 million, or 16.9% to $8.0 million in the first three quarters of fiscal 2019 from $6.9 million in the prior year period. This increase is principally related to higher compensation and benefit expenses related to a larger staff, severance charges, and legal and professional fees associated with the Company’s ongoing litigation and the SolSys merger.

 

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Research and development expenses

 

Research and development expenses increased by $0.5 million or 16.7% to $3.6 million in the first three quarters of fiscal 2019 from $3.1 million in the prior year period. The Company is investing in the design and development of its next generation platform product, Nexus, which is expected to be available in mid-2019, subject to approval by the FDA of the Company’s 510(k) application. During the first three quarters of fiscal 2019 and 2018, approximately $1.8 million and $1.9 million, respectively, was charged to research and development expenses related to this product.

 

Other income (expense)

 

Other income was $28,891 in fiscal 2019 compared with $519,095 in the prior year period. This decrease related to the royalty income from MMIT in the prior year. This royalty agreement expired in August 2018.

 

Income taxes

 

For the nine months ended March 31, 2019 and 2018, the Company recorded an income tax expense of $0 and $5,243,422, respectively. For the nine months ended March 31, 2019 and 2018, the effective rate of 0% and (892.7%), respectively, varied from the U.S. federal statutory rate due to changes in the Company’s projected pretax book income.

 

The income tax expense for the first three quarters of fiscal 2018 included a one-time charge of $1,764,039 to revalue the Company’s deferred tax assets as of December 31, 2017 to give effect to the reduction in corporate tax rates to 21% effective January 1, 2018, as a result of the Tax Cuts and Jobs Act of 2018, enacted on December 22, 2017. Income tax expense also included a $3.6 million charge to record a full valuation allowance against the Company’s remaining deferred tax assets. In accordance with the guidance of ASC Topic 740, management concluded that in its judgment, the Company’s deferred tax assets at March 31, 2019 are not more likely-than-not realizable.

 

Income tax expense for the nine months ended March 31, 2019 includes a $1,164,000 valuation allowance against the Company’s deferred tax assets recorded in the period. In accordance with the guidance of ASC Topic 740, management concluded that in its judgment, the Company’s deferred tax assets at March 31, 2019 are not more likely-than-not realizable. The components of the tax provision are as follows:

 

   For the nine months ended 
   March 31, 
   2019   2018 
         
Income tax expense (benefit)  $(1,164,000)  $(97,744)
Reduction of deferred tax assets relating to Tax Legislation       1,764,039 
Valuation allowance on deferred tax assets   1,164,000    3,577,127 
           
Net income tax expense  $   $5,243,422 

 

Liquidity and Capital Resources

 

Working capital at March 31, 2019 was $15.7 million. For the nine months ended March 31, 2019, cash used in operations was $2.6 million, consisting of $5.0 million relating to the loss from operations for the period, offset by $3.1 million of non-cash charges, and $0.7 million for increased working capital.

 

Cash used in investing activities during the nine months ended March 31, 2019 was $0.7 million, primarily consisting of the purchase of property, plant and equipment along with filing for additional patents.

 

Cash provided by financing activities during the nine months ended March 31, 2019 was $1.4 million, resulting from stock option exercises.

  

As of March 31, 2019, the Company had cash and cash equivalents of approximately $9.0 million and believes it has sufficient cash to finance operations for at least the next 12 months.

 

Relating to the internal investigation described herein, the Company has incurred approximately $3.4 million in investigative costs through March 31, 2019. Further, the Company could be subject to fines or penalties related to potential violations of the FCPA.

 

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The Company is investing in the design and development of its next generation platform product, Nexus, of which $1.8 million in development costs have been incurred during the nine months ended March 31, 2019.

 

Off-Balance Sheet Arrangements

 

The Company has no off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on the Company’s financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that are material to the Company.

 

Other

 

In the opinion of management, inflation has not had a material effect on the operations of the Company.

 

Recent Accounting Pronouncements

 

See Note 1 to The Company’s condensed consolidated financial statements included herein.

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk

 

Market Risk:

 

The principal market risks (i.e., the risk of loss arising from adverse changes in market rates and prices) to which the Company is exposed are interest rates on cash and cash equivalents.

 

Interest Rate Risk:

 

The Company earns interest on cash balances and pays interest on any debt incurred. In light of the Company’s existing cash, results of operations and projected borrowing requirements, the Company does not believe that a 10% change in interest rates would have a significant impact on its consolidated financial position.

  

Item 4. Controls and Procedures

 

Evaluation of Disclosure Controls and Procedures

 

We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) that are designed to provide reasonable assurance that information required to be disclosed in reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC and that such information is accumulated and communicated to our management, including the Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosures.

 

All internal control systems, no matter how well designed and tested, have inherent limitations, including, among other things, the possibility of human error, circumvention or disregard. Therefore, even those systems of internal control that have been determined to be effective can provide only reasonable assurance that the objectives of the control system are met and may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

We carried out an evaluation, under the supervision and with the participation of management, of the effectiveness of the design and operation of our disclosure controls and procedures as of March 31, 2019. Based on that evaluation, and having concluded that the material weakness in our internal control over financial reporting initially reported in our Annual Report on Form 10-K for the fiscal year ended June 30, 2018 and in our subsequent Quarterly Report on Form 10-Q for the quarter ended September 30, 2018, has been remediated and our chief executive officer and chief financial officer have concluded that our disclosure controls and procedures were effective as of March 31, 2019.

 

Changes in Internal Control over Financial Reporting

 

There were no changes in our internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the quarter ended March 31, 2019 that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

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PART II - OTHER INFORMATION

 

Item 1. Legal Proceedings

 

See Note 10. Commitments and Contingencies to our condensed consolidated financial statements included herein.

 

Item 1A. Risk Factors.

 

Risks and uncertainties that, if they were to occur, could materially adversely affect our business or that could cause our actual results to differ materially from the results contemplated by the forward-looking statements contained in this Report and other public statements were set forth in the Item 1A. - “Risk Factors” section of our Form 10-K for the fiscal year ended June 30, 2018. There have been no material changes from the risk factors disclosed in that Form 10-K.

 

Item 6. Exhibits

 

Exhibit No.   Description
     
3.1   Articles of Amendment and Restated Certificate of Incorporation of Misonix, Inc.
     
31.1   Chief Executive Officer-Certification pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
     
31.2   Chief Financial Officer-Certification pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
     
32.1   Chief Executive Officer-Certification pursuant to Rule 13a-14(b) or Rule 15d-14(b) of the Securities Exchange Act of 1934 and 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes- Oxley Act of 2002.
     
32.2   Chief Financial Officer-Certification pursuant to Rule 13a-14(b) or Rule 15d-14(b) of the Securities Exchange Act of 1934 and 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes- Oxley Act of 2002.
     
101.INS   XBRL Instance Document
     
101.SCH   XBRL Taxonomy Extension Scheme Document
     
101.CAL   XBRL Taxonomy Extension Calculation Linkbase Document
     
101.DEF   XBRL Taxonomy Extension Definition Linkbase Document
     
101.LAB   XBRL Taxonomy Extension Label Linkbase Document
     
101.PRE   XBRL Taxonomy Extension Presentation Linkbase Document

 

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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 thereunto duly authorized.

 

  MISONIX, INC.
     
Dated: May 8, 2019 By: /s/ Stavros G. Vizirgianakis
    Stavros G. Vizirgianakis
    Chief Executive Officer
     
  By: /s/ Joseph P. Dwyer
    Joseph P. Dwyer
    Chief Financial Officer

 

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