UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the quarterly period ended AUGUST 31, 2005
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 0-19095
SOMANETICS CORPORATION
(Exact name of registrant as specified in its charter)
MICHIGAN 38-2394784
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
1653 EAST MAPLE ROAD,
TROY, MICHIGAN
48083-4208
(Address of principal executive offices)
(Zip Code)
(248) 689-3050
(Registrant's telephone number, including area code)
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 an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes No X
----- -----
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act).
Yes No X
----- -----
Number of common shares outstanding at October 12, 2005: 10,683,179
PART I FINANCIAL INFORMATION
SOMANETICS CORPORATION
BALANCE SHEETS
August 31, November 30,
2005 2004
------------ ------------
(Unaudited) (Audited)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents .......................................... $ 11,699,124 $ 7,069,542
Accounts receivable ................................................ 2,464,357 2,022,544
Inventory .......................................................... 920,037 682,910
Prepaid expenses ................................................... 153,982 257,893
Deferred tax asset - current ....................................... 743,429 510,000
------------ ------------
Total current assets ............................................ 15,980,929 10,542,889
------------ ------------
PROPERTY AND EQUIPMENT (at cost):
Demonstration and no-cap sales equipment at customers .............. 1,859,228 1,628,431
Machinery and equipment ............................................ 754,506 704,581
Furniture and fixtures ............................................. 289,397 255,044
Leasehold improvements ............................................. 187,136 171,882
------------ ------------
Total ........................................................... 3,090,267 2,759,938
Less accumulated depreciation and amortization ..................... (1,768,300) (1,675,881)
------------ ------------
Net property and equipment ...................................... 1,321,967 1,084,057
------------ ------------
OTHER ASSETS:
Deferred tax asset - non-current ................................... 4,695,348 6,190,000
Intangible assets, net ............................................. 947,742 952,926
Other .............................................................. 15,000 15,000
------------ ------------
Total other assets .............................................. 5,658,090 7,157,926
------------ ------------
TOTAL ASSETS .......................................................... $ 22,960,986 $ 18,784,872
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable ................................................... $ 646,550 $ 529,097
Accrued liabilities ................................................ 881,531 703,109
------------ ------------
Total current liabilities ....................................... 1,528,081 1,232,206
------------ ------------
COMMITMENTS AND CONTINGENCIES
SHAREHOLDERS' EQUITY:
Preferred shares; authorized, 1,000,000 shares of $.01 par value;
no shares issued or outstanding ................................. -- --
Common shares; authorized, 20,000,000 shares of $.01 par value;
issued and outstanding, 10,427,133 shares at August 31, 2005,
and 10,137,782 shares at November 30, 2004 ...................... 104,271 101,378
Additional paid-in capital ......................................... 63,762,525 62,333,435
Accumulated deficit ................................................ (42,433,891) (44,882,147)
------------ ------------
Total shareholders' equity ...................................... 21,432,905 17,552,666
------------ ------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY ............................ $ 22,960,986 $ 18,784,872
============ ============
See notes to financial statements
2
SOMANETICS CORPORATION
STATEMENTS OF OPERATIONS
(Unaudited)
Three Months Nine Months
Ended August 31, Ended August 31,
------------------------- -------------------------
2005 2004 2005 2004
----------- ----------- ----------- -----------
NET REVENUES .............................. $ 5,242,848 $ 3,076,373 $14,358,211 $ 8,779,614
COST OF SALES ............................. 661,196 443,837 1,856,185 1,483,546
----------- ----------- ----------- -----------
GROSS MARGIN .............................. 4,581,652 2,632,536 12,502,026 7,296,068
----------- ----------- ----------- -----------
OPERATING EXPENSES:
Research, development and engineering .. 95,924 87,001 296,441 269,418
Selling, general and administrative .... 3,064,857 2,019,128 8,685,648 5,810,669
----------- ----------- ----------- -----------
Total operating expenses ............ 3,160,781 2,106,129 8,982,089 6,080,087
----------- ----------- ----------- -----------
OPERATING INCOME .......................... 1,420,871 526,407 3,519,937 1,215,981
----------- ----------- ----------- -----------
OTHER INCOME:
Interest income ........................ 85,413 13,315 189,542 26,216
----------- ----------- ----------- -----------
Total other income ..................... 85,413 13,315 189,542 26,216
----------- ----------- ----------- -----------
NET INCOME BEFORE INCOME TAXES ............ 1,506,284 539,722 3,709,479 1,242,197
----------- ----------- ----------- -----------
INCOME TAX PROVISION ...................... 512,136 -- 1,261,223 --
----------- ----------- ----------- -----------
NET INCOME ................................ $ 994,147 $ 539,722 $ 2,448,256 $ 1,242,197
----------- ----------- ----------- -----------
NET INCOME PER COMMON
SHARE - BASIC .......................... $ 0.10 $ 0.05 $ 0.24 $ 0.13
----------- ----------- ----------- -----------
NET INCOME PER COMMON
SHARE - DILUTED ........................ $ 0.08 $ 0.05 $ 0.21 $ 0.11
----------- ----------- ----------- -----------
WEIGHTED AVERAGE SHARES
OUTSTANDING - BASIC .................... 10,360,990 10,098,237 10,227,923 9,662,716
=========== =========== =========== ===========
WEIGHTED AVERAGE SHARES
OUTSTANDING - DILUTED .................. 12,102,611 11,913,495 11,850,418 11,353,955
=========== =========== =========== ===========
See notes to financial statements
3
SOMANETICS CORPORATION
STATEMENTS OF CASH FLOWS
(UNAUDITED)
For the Nine Month
Periods Ended
------------------------
August 31, August 31,
2005 2004
----------- ----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income ................................................... $ 2,448,256 $1,242,197
Adjustments to reconcile net income to net cash provided by
operations:
Income tax provision ...................................... 1,261,223 --
Depreciation and amortization ............................. 276,967 199,317
Compensation expense for non-employee stock options ....... 7,013 --
Changes in assets and liabilities:
Accounts receivable (increase) decrease ................ (441,813) 268,256
Inventory (increase) ................................... (627,277) (91,332)
Prepaid expenses decrease .............................. 103,911 17,620
Accounts payable increase (decrease) ................... 117,453 (125,746)
Accrued liabilities increase ........................... 178,422 18,981
----------- ----------
Net cash provided by operations ..................... 3,324,155 1,529,293
----------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisition of property and equipment (net) .................. (119,543) (93,169)
----------- ----------
Net cash (used in) investing activities ............. (119,543) (93,169)
----------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common shares due to exercise
of stock options and warrants ................................ 1,424,970 2,666,022
----------- ----------
Net cash provided by financing activities ........... 1,424,970 2,666,022
----------- ----------
NET INCREASE IN CASH AND CASH
EQUIVALENTS .................................................. 4,629,582 4,102,146
CASH AND CASH EQUIVALENTS, BEGINNING
OF PERIOD .................................................... 7,069,542 2,239,192
----------- ----------
CASH AND CASH EQUIVALENTS, END
OF PERIOD .................................................... $11,699,124 $6,341,338
=========== ==========
Supplemental Disclosure of Non cash investing activities:
Demonstration and no-cap sales equipment capitalized
from inventory (Note 2) ...................................... $ 390,150 $ 404,777
See notes to financial statements
4
SOMANETICS CORPORATION
NOTES TO FINANCIAL STATEMENTS
(UNAUDITED)
AUGUST 31, 2005
1. FINANCIAL STATEMENT PRESENTATION
We prepared our unaudited interim financial statements pursuant to the
Securities and Exchange Commission's rules. These interim financial statements
do not include all of the information and notes normally included in our annual
financial statements prepared in accordance with generally accepted accounting
principles. We believe, however, that the disclosures are adequate to make the
information presented not misleading.
The unaudited interim financial statements in this report reflect all
adjustments which are, in our opinion, necessary to a fair statement of the
results for the interim periods presented. All of these adjustments that are
material are of a normal recurring nature. Our operating results for the
nine-month period ended August 31, 2005 do not necessarily indicate the results
that you should expect for the year ending November 30, 2005. You should read
the unaudited interim financial statements together with the financial
statements and related notes for the year ended November 30, 2004 included in
our Annual Report on Form 10-K for the fiscal year ended November 30, 2004.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Inventory is stated at the lower of cost or market on a first-in, first-out
(FIFO) basis. Inventory consists of:
August 31, 2005 November 30, 2004
--------------- -----------------
Finished goods ........ $449,651 $358,815
Purchased components .. 430,401 323,053
Work in process ....... 39,985 1,042
-------- --------
Total .............. $920,037 $682,910
======== ========
Property and Equipment are stated at cost. Depreciation and amortization
are computed using the straight-line method over the estimated useful lives of
the assets, which range from two to five years. We offer to our United States
customers a no-cap sales program whereby we ship the Cerebral Oximeter to the
customer at no charge, in exchange for the customer agreeing to purchase
SomaSensors. The Cerebral Oximeters that are shipped to our customers are
classified as no-cap sales equipment and are depreciated over five years. During
the first nine months of fiscal 2005 and fiscal 2004, costs capitalized from
inventory for Cerebral Oximeters being used as demonstration and no-cap sales
equipment at customer locations were approximately $390,000 and $405,000,
respectively. Property and equipment are reviewed for impairment whenever events
or changes in circumstances indicate that the net book value of the asset may
not be recovered.
Intangible Assets consist of patents and trademarks, and license
acquisition costs. Patents and trademarks are recorded at cost and are being
amortized on the straight-line method over 17 years. The carrying amount and
accumulated amortization of these patents and trademarks are as follows:
August 31, 2005 November 30, 2004
--------------- -----------------
Patents and trademarks ............... $111,733 $111,733
Less accumulated amortization ..... (93,084) (87,900)
-------- --------
Total .......................... $ 18,649 $ 23,833
======== ========
5
SOMANETICS CORPORATION
NOTES TO FINANCIAL STATEMENTS
(UNAUDITED)
AUGUST 31, 2005
Amortization expense for the nine months ended August 31, 2005 and August
31, 2004 was approximately $5,200. Amortization expense for each of the next
three fiscal years is expected to be approximately $6,900 per year, and
approximately $3,100 in fiscal 2008.
License acquisition costs are related to our acquisition of exclusive,
worldwide, royalty-bearing licenses to specified rights relating to the
CorRestore System, and related products and accessories. In exchange for the
licenses and consulting services, we agreed to the following compensation for
CorRestore LLC and its agent, Joe B. Wolfe: (1) a royalty of 10% of our "net
sales" of products subject to the licenses, (2) five-year warrants to purchase
up to 400,000 common shares at $3.00 a share, exercisable to purchase 300,000
shares immediately and to purchase an additional 50,000 shares upon our receipt
of clearance or approval from the FDA to market the CorRestore Patch in the
United States and another 50,000 shares upon our receipt of CE certification for
the CorRestore System, (3) additional five-year warrants to purchase up to
2,100,000 common shares at $3.00 a share, granted when we received clearance
from the FDA to market the CorRestore Patch in the United States, exercisable
based on our cumulative net sales of the CorRestore System products, and (4) a
consulting fee of $25,000 a year to each of the inventors until we sell 1,000
CorRestore Patches.
In April 2004, CorRestore LLC exercised its warrant to purchase 380,000 of
our newly-issued common shares, at $3.00 per share, for proceeds of $1,140,000.
In May 2005, Joe B. Wolfe, agent for CorRestore LLC and one of our former
directors, purchased 20,000 common shares under his warrants by a cashless
exercise. As a result of this cashless exercise, we issued 16,264 common shares
to Mr. Wolfe, retaining 3,736 common shares in payment of the exercise price.
CorRestore LLC and Mr. Wolfe have no vested warrants remaining to purchase
common shares.
License acquisition costs consist of professional service fees recorded at
cost, our estimate of the fair value of the ten-year vested stock options to
purchase 50,000 common shares at $3.00 a share granted to one of our then
current directors in connection with negotiating and assisting us in completing
the transaction, and our estimate of the fair value of the 400,000 common share
vested portion of the five-year warrants to purchase common shares at $3.00 a
share issued in the transaction. Consistent with the treatment of the warrants
to purchase 400,000 common shares, we intend to include in license acquisition
costs, and additional paid in capital, the fair value of the vested portion of
the warrants to purchase 2,100,000 common shares, estimated using the
Black-Scholes valuation model, when and if they become vested. However, we do
not expect any of these warrants to become vested before their November 21, 2006
expiration date, based on sales of CorRestore products to date.
The total carrying amount of these license acquisition costs is as follows:
August 31, 2005 November 30, 2004
--------------- -----------------
License acquisition costs .. $929,093 $929,093
License acquisition costs are intangible assets with indefinite lives that
are reviewed annually for impairment at the end of our fiscal year, and whenever
events or changes in circumstances indicate that the carrying value of the asset
may not be recovered. We evaluate impairment by comparing the fair value of the
intangible asset, determined using a cash flow method, with its carrying value.
6
SOMANETICS CORPORATION
NOTES TO FINANCIAL STATEMENTS
(UNAUDITED)
AUGUST 31, 2005
Stock Options In October 1995, Statement of Financial Accounting Standards
No. 123, "Accounting for Stock-Based Compensation," was issued. In December
2004, the Financial Accounting Standards Board issued Statement of Financial
Accounting Standards No. 123 (revised), Share Based Payment. This Statement
revises Statement No. 123, "Accounting for Stock-Based Compensation," and
requires that compensation costs related to share-based payment transactions,
including stock options, restricted stock and restricted stock units be
recognized in the financial statements. This Statement will be effective for our
fiscal quarter ending February 28, 2006. We expect the equity compensation to be
recognized in our statement of operations for fiscal 2006, related to unvested
stock options as of our required adoption date, will be the equivalent of $.03
per diluted common share. Future equity compensation grants in 2005 and beyond
would have an additional impact on our financial statements.
We currently account for stock-based compensation of employees using the
intrinsic value method prescribed in Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees," and related interpretations.
However, we have also adopted the enhanced disclosure provisions as defined by
Statement No. 148, "Accounting for Stock-Based Compensation - Transition and
Disclosure." Stock-based compensation of consultants and advisors is determined
based on the fair value of the options or warrants on the grant date pursuant to
the methodology of SFAS No. 123, estimated using the Black-Scholes model. The
resulting amount is recognized as compensation expense and an increase in
additional paid-in capital over the vesting period of the options or warrants.
As a result, we recorded $7,013 of compensation expense, and an equal increase
in additional paid in capital, for stock options issued to non-employees during
the first three quarters of fiscal 2005, and we recorded no such expense in
fiscal 2004. During the first three quarters of fiscal 2005 we granted 168,257
stock options to our employees, directors and one of our consultants, and we
issued 273,087 newly-issued common shares as a result of stock option exercises.
During the first three quarters of fiscal 2004, we granted 50,500 stock options
to our employees and directors, and we issued 318,276 newly-issued common shares
as a result of stock option exercises.
Had compensation expense for stock options that vested in the first three
quarters been determined based on the fair value of the options on the grant
date pursuant to the methodology of SFAS No. 123, our results of operations, on
a pro forma basis, would have been as follows:
FOR THE THREE MONTHS ENDED FOR THE NINE MONTHS ENDED
--------------------------------- ---------------------------------
AUGUST 31, 2005 AUGUST 31, 2004 AUGUST 31, 2005 AUGUST 31, 2004
--------------- --------------- --------------- ---------------
Net income ............................... $ 994,147 $ 539,722 $ 2,448,256 $1,242,197
Add: Stock-based employee compensation
included in actual net income ......... $ 4,208 $ 0 $ 7,013 $ 0
Deduct: Total stock-based employee
compensation expense, had fair value
method been applied ................... $(721,957) $(197,198) $(1,315,687) $ (566,590)
--------- --------- ----------- ----------
Pro-forma net income ..................... $ 276,398 $ 342,524 $ 1,139,582 $ 675,607
========= ========= =========== ==========
Net income per common share -
diluted ............................... $ .08 $ .05 $ .21 $ .11
Pro forma net income per common
share - diluted ....................... $ .02 $ .03 $ .10 $ .06
7
SOMANETICS CORPORATION
NOTES TO FINANCIAL STATEMENTS
(UNAUDITED)
AUGUST 31, 2005
Net Income Per Common Share - basic and diluted is computed using the
weighted average number of common shares outstanding during each period.
Weighted average shares outstanding - diluted includes the potential dilution
that could occur for common stock issuable under stock options or warrants. The
difference between weighted average shares - diluted and weighted average shares
- basic is calculated as follows:
2005
--------------------------
Three Months Nine Months
------------ -----------
Weighted average shares - basic 10,360,990 10,227,923
Add: effect of dilutive common
shares and warrant 1,741,621 1,622,495
---------- ----------
Weighted average shares - diluted 12,102,611 11,850,418
2004
--------------------------
Three Months Nine Months
------------ -----------
Weighted average shares - basic 10,098,237 9,662,716
Add: effect of dilutive common
shares and warrant 1,815,258 1,691,239
---------- ----------
Weighted average shares - diluted 11,913,495 11,353,955
For the three and nine months ended August 31, 2005, the number of stock
options that were excluded from the computation of net income per common share -
diluted, because the exercise price of the options exceeded the average price
per share of our common shares, was approximately 500, and the number of
warrants excluded from the calculation was 2,100,000, as they are contingent on
achieving specified future sales targets that we do not expect to achieve. For
the three and nine months ended August 31, 2004, there were approximately 22,000
stock options outstanding that were excluded from the computation of net income
per common share - diluted, and there were approximately 1,866,000 warrants
outstanding that were excluded from the computation. As of August 31, 2005 and
August 31, 2004, we had outstanding warrants and options to purchase common
shares of 4,303,151 and 4,439,915, respectively.
Reclassifications Certain reclassifications have been made to the financial
statements for 2004 to conform to 2005 presentation.
3. INCOME TAXES
During fiscal 2004, we adjusted our deferred tax asset valuation allowance
resulting in the recognition of a deferred tax asset of $6,700,000 related to
the expected future benefits of our net operating loss carryforwards, in
accordance with Statement of Financial Accounting Standards No. 109, "Accounting
for Income Taxes." We have performed the required assessment of positive and
negative evidence regarding realization of our deferred tax assets in accordance
with SFAS No. 109, including our past operating results, the existence of
cumulative losses over our history up to the most recent two fiscal years, and
our forecast for future net income. The primary assumption underlying our
determination that the net asset will be realized is that our revenues and
pre-tax income will grow in future years consistent with the original growth
guidance given for fiscal 2005. Our assessment of our deferred tax assets, and
the reversal of part of our valuation allowance, included evaluating our
financial plans and our future projected earnings, making allowance for the
uncertainties surrounding, among other things, our future rate of growth in net
revenues, the rate of adoption of our products in the marketplace, and the
potential for competition to enter the marketplace.
8
SOMANETICS CORPORATION
NOTES TO FINANCIAL STATEMENTS
(UNAUDITED)
AUGUST 31, 2005
In reversing a portion of our valuation allowance, we have concluded that
it is more likely than not that such assets will be realized. Given the
assumptions inherent in our financial plans, it is possible to calculate a
different value for our deferred tax asset by changing one or more of the
variables in our assessment. However, we believe that our evaluation of our
financial plans was reasonable, and that the judgments and assumptions that we
made at the time of developing the plan were appropriate.
During the first quarter of fiscal 2005, we began recognizing income tax
expense at an estimated effective tax rate of 34% on our statement of
operations. As we assess our plans for future years, we will continue to review
the appropriateness of adjusting our deferred tax asset valuation allowance and
recognizing additional net deferred tax assets.
4. ACCRUED LIABILITIES
Accrued liabilities consist of the following:
August 31, 2005 November 30, 2004
--------------- -----------------
Incentive compensation .. $471,548 $390,978
Sales commissions ....... 256,352 153,180
Professional fees ....... 115,225 42,000
Warranty ................ 14,800 10,750
401(k) match ............ 13,160 97,071
Royalty ................. 10,445 9,130
-------- --------
Total ................ $881,530 $703,109
======== ========
5. COMMITMENTS AND CONTINGENCIES
We may become subject to products liability claims by patients or
physicians, and may become a defendant in products liability or malpractice
litigation. We have obtained products liability insurance and an umbrella
policy. We might not be able to maintain such insurance or such insurance might
not be sufficient to protect us against products liability.
We have employment agreements or change in control, invention,
confidentiality, non-compete and non-solicitation agreements with all of our
executive officers. The employment agreement with our Vice President, Sales and
Marketing and the change in control agreements with five of our executive
officers provide for severance benefits equal to one year's salary upon
termination of employment without cause or for good reason 90 days before to one
year after a change in control of the Company that occurs by June 13, 2008. The
employment agreement with our President and Chief Executive Officer provides for
severance benefits equal to one year's salary and six months of benefits upon
termination of his employment without cause or if his employment terminates
because his agreement expires. His employment agreement expires April 30, 2006
unless earlier terminated as provided in the agreement. All executive officers
have agreed not to compete with us and not to solicit our employees during
specified periods following the termination of employment, and they have agreed
to various confidentiality obligations. The estimated financial exposure of
these employment agreements, upon a change of control of the Company and
termination of all of the executives without cause, is approximately $934,000.
9
SOMANETICS CORPORATION
NOTES TO FINANCIAL STATEMENTS
(UNAUDITED)
AUGUST 31, 2005
6. COMMON STOCK
On April 21, 2005, our shareholders approved the Somanetics Corporation
2005 Stock Incentive Plan. The Plan permits us to grant stock options, including
both nonqualified options and incentive options, restricted stock and restricted
stock units to our officers, other employees, non-employee directors,
consultants, advisors, independent contractors and agents, up to 600,000 common
shares.
In April 2005, we granted 10-year options under the 1997 Stock Option Plan
to purchase 67,041 common shares, and 10-year options under the 2005 Stock
Incentive Plan to purchase 71,216 common shares, to 20 of our employees and one
of our consultants at an exercise price of $13.55 per share (the average of the
high and low sale prices of the common shares as of the date of grant). In May
2005, we granted 10-year options under the 2005 Stock Incentive Plan to purchase
30,000 common shares to three of our directors at an exercise price of $14.92
per share (the average of the high and low sale prices of the common shares as
of the date of grant).
During the first three quarters of fiscal 2005, we issued 273,087 common
shares as a result of stock option exercises for proceeds of approximately
$1,425,000.
In May 2005, Joe B. Wolfe, agent for CorRestore LLC and one of our former
directors, purchased 20,000 common shares under his warrants by a cashless
exercise. As a result of this cashless exercise, we issued 16,264 common shares
to Mr. Wolfe, retaining 3,736 common shares in payment of the exercise price.
Mr. Wolfe has no vested warrants remaining to purchase common shares.
7. SEGMENT INFORMATION
We operate our business in one reportable segment, the development,
manufacture and marketing of medical devices. Each of our two product lines have
similar characteristics, customers, distribution and marketing strategies, and
are subject to similar regulatory requirements. In addition, in making operating
and strategic decisions, our management evaluates net revenues based on the
worldwide net revenues of each major product line, and profitability on an
enterprise-wide basis due to shared costs. Approximately 97% of our net revenues
in the first three quarters of fiscal 2005 were derived from our INVOS Cerebral
Oximeter product line, compared to 95% of our net revenues in the first three
quarters of fiscal 2004.
10
SOMANETICS CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
AUGUST 31, 2005
Some of the statements in this report are forward-looking statements. These
forward-looking statements include statements relating to our performance in
this Management's Discussion and Analysis of Financial Condition and Results of
Operations. In addition, we may make forward-looking statements in future
filings with the Securities and Exchange Commission and in written material,
press releases and oral statements issued by us or on our behalf.
Forward-looking statements include statements regarding the intent, belief or
current expectations of us or our officers, including statements preceded by,
followed by or including forward-looking terminology such as "may," "will,"
"should," "believe," "expect," "anticipate," "estimate," "continue," "predict"
or similar expressions, with respect to various matters.
Our actual results might differ materially from those projected in the
forward-looking statements depending on various important factors. These
important factors include economic conditions in general and in the healthcare
market, the demand for and market for our products in domestic and international
markets, our current dependence on the Cerebral Oximeter and SomaSensor, the
challenges associated with developing new products and obtaining regulatory
approvals if necessary, research and development activities, the uncertainty of
acceptance of our products by the medical community, the lengthy sales cycle for
our products, third party reimbursement, competition in our markets, including
the potential introduction of competitive products by others, our dependence on
our distributors, physician training, enforceability and the costs of
enforcement of our patents, potential infringements of our patents and the other
factors discussed under the caption "Risk Factors" and elsewhere in our
Registration Statement on Form S-1 (file no. 333-74788) effective January 11,
2002 and elsewhere in this report, all of which constitute cautionary statements
identifying important factors with respect to the forward-looking statements,
including certain risks and uncertainties, that could cause actual results to
differ materially from those in such forward-looking statements.
All forward-looking statements in this report are based on information
available to us on the date of this report. We do not undertake to update any
forward-looking statements that may be made by us or on our behalf in this
report or otherwise.
RESULTS OF OPERATIONS
OVERVIEW
We develop, manufacture and market the INVOS Cerebral Oximeter, the only
non-invasive patient monitoring system commercially available in the United
States that continuously measures changes in the blood oxygen level in the
brain. We also develop and market the CorRestore System for use in cardiac
repair and reconstruction, including heart surgeries called surgical ventricular
restoration, or SVR.
During fiscal 2004 and the first three quarters of fiscal 2005, our primary
activities consisted of sales and marketing of the Cerebral Oximeter, the
related disposable SomaSensor, and the CorRestore System.
We derive our revenues from sales of Cerebral Oximeters, SomaSensors and
CorRestore Systems to our distributors and to hospitals in the United States
through our direct sales employees and independent sales representative firms.
We offer to our customers in the United States a no-cap sales program whereby we
ship the Cerebral Oximeter to the customer at no charge, in exchange for the
customer agreeing to purchase SomaSensors. Payment terms are generally net 30
days for United States sales and net 60 days or longer for international sales.
Our primary expenses, excluding the cost of our products, are selling, general
and administrative and research, development and engineering.
11
SOMANETICS CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
AUGUST 31, 2005
As described in more detail below, for the nine months ended August 31,
2005, we achieved an increase in net income before income taxes of approximately
199%, primarily as a result of an increase in net revenues of approximately 64%
and an increase in gross margin percentage to approximately 87%. Our increase in
net revenues was primarily a result of increased unit sales and increased
average selling prices for our disposable SomaSensor in the United States,
increased sales of the Cerebral Oximeter to pediatric hospitals in the United
States and increased international sales. Our increase in gross margin
percentage was also primarily attributable to the increased sales of the
Cerebral Oximeter to pediatric hospitals and the increase in the average selling
prices for our disposable SomaSensors, as well as the reduction in the cost of
our disposable SomaSensor by approximately 40%, effective May 2004, as a result
of changes in our manufacturing process. Our operating expenses increased
approximately 48% for the nine month period primarily due to our hiring
additional sales personnel in fiscal 2004 and 2005, increased commissions paid
to our independent sales representative firms and direct sales employees as a
result of increased sales, increased selling expenses, increased accrued
incentive compensation and costs associated with our first Sarbanes-Oxley
internal control assessment. We had approximately $3,324,000 of cash provided by
operations in the first three quarters of fiscal 2005, and a net increase in
cash and cash equivalents of approximately $4,630,000.
For 2005, we project an increase in net revenues of approximately 59% to
63%, to approximately $20.0 million to $20.5 million, and we also project an
increase in net income before income taxes of approximately 135% to 150%, to
approximately $4.7 million to $5.0 million. In addition, we expect to realize a
net increase in cash and cash equivalents of approximately $5.4 million, and we
expect that our year-end cash balances will be approximately $12.5 million.
While we do not expect to pay income taxes for fiscal 2005, beginning in the
first quarter of 2005, we began recognizing income tax expense at an estimated
effective tax rate of 34% on our statement of operations. As we assess our plans
for future years, we will continue to review the appropriateness of adjusting
our deferred tax asset valuation allowance and recognizing additional net
deferred tax assets.
THREE MONTHS ENDED AUGUST 31, 2005 COMPARED TO THREE MONTHS ENDED AUGUST 31,
2004
Our net revenues increased $2,166,475, or 70%, from $3,076,373 in the
three-month period ended August 31, 2004 to $5,242,848 in the three-month period
ended August 31, 2005. The increase in net revenues is attributable to
- an increase in United States sales of approximately $1,814,000,
or 70%, from approximately $2,600,000 in the third quarter of
fiscal 2004 to approximately $4,414,000 in the third quarter of
fiscal 2005. This increase is primarily due to an increase in
sales of the disposable SomaSensor of approximately $1,492,000,
or 64%, as a result of a 45% increase in SomaSensor unit sales,
driven primarily by increased sales personnel and recent clinical
research data, and a 13% increase in SomaSensor average selling
prices. In addition, Cerebral Oximeter revenues increased
approximately $346,000, or 241%, due to increased purchases by
pediatric hospitals, and
- an increase in international sales of approximately $353,000, or
74%, from approximately $476,000 in the third quarter of fiscal
2004 to approximately $829,000 in the third quarter of fiscal
2005, primarily attributable to increased purchases of the
Cerebral Oximeter by Tyco Healthcare.
12
SOMANETICS CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
AUGUST 31, 2005
As described above, during the third quarter we achieved a 13% increase in
the average selling price of SomaSensors in the United States. The increase in
the average selling price is primarily attributable to the addition of new
customers at our higher suggested retail prices and increased sales of our
pediatric SomaSensor, which sells for a premium price. In addition, as described
above, we had a 45% increase in SomaSensor unit sales in the United States to
41,720 units. We expect that the average selling price of SomaSensors in the
United States will increase by at least 10% in 2005 compared to 2004 as a result
of the factors described above.
We placed 76 new Cerebral Oximeters in the United States in the third
quarter of 2005, and we estimate that the installed base of Cerebral Oximeters
in the United States is approximately 985, in approximately 455 hospital
accounts, as of August 31, 2005. Internationally we sold 58 Cerebral Oximeters
and 13,290 SomaSensors during the third quarter of 2005.
Approximately 16% of our net revenues in the third quarter of fiscal 2005
were from export sales, compared to approximately 15% in the third quarter of
fiscal 2004. We expect international net revenues to represent approximately 15%
to 20% of total net revenues in 2005. During the third quarter of 2005, one
international distributor (Europe) represented approximately 12% of our net
revenues, and during the third quarter of fiscal 2004, one international
distributor (Europe) represented approximately 10% of our net revenues.
Sales of our products as a percentage of net revenues were as follows:
PERCENT OF NET REVENUE
THIRD QUARTER OF FISCAL
-----------------------
PRODUCT 2005 2004
------- ---- ----
SomaSensors.......... 79% 85%
Cerebral Oximeters... 19% 11%
CorRestore Systems... 2% 4%
--- ---
Total............. 100% 100%
=== ===
For 2005, we expect sales of SomaSensors to account for 75% to 80% of net
revenues, sales of Cerebral Oximeters 20% to 25%, and sales of CorRestore
Systems less than 5%.
Gross margin as a percentage of net revenues was approximately 87% for the
quarter ended August 31, 2005 and approximately 86% for the quarter ended August
31, 2004. The increase in gross margin as a percentage of net revenues is
primarily attributable to the increase in the average selling price of
SomaSensors described above, and increased sales of the Cerebral Oximeter to
pediatric hospitals in the United States. We expect our gross margin percentage
to be approximately 87% in fiscal 2005, primarily due to the factors described
above.
Our research, development and engineering expenses increased $8,923, or
10%, from $87,001 for the three months ended August 31, 2004 to $95,924 for the
three months ended August 31, 2005. The increase is primarily attributable to
increased development costs associated with the Cerebral Oximeter. We expect our
research and development expenses to increase in the fourth quarter of 2005
primarily as a result of design and development costs associated with our next
generation cerebral oximeter and smaller pediatric SomaSensor, and the addition
of one engineer.
13
SOMANETICS CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
AUGUST 31, 2005
Selling, general and administrative expenses increased approximately
$1,046,000, or 52%, from $2,019,128 for the quarter ended August 31, 2004 to
$3,064,857 for the quarter ended August 31, 2005, primarily due to a 53%
increase in our sales and marketing expenses during the third quarter of fiscal
2005 because of our increased sales personnel and our increased sales and
marketing efforts. The increase in selling, general and administrative expense
is primarily attributable to
- a $251,000 increase in salaries, wages, and related expenses,
primarily as a result of an increase in the number of employees,
principally sales and marketing (from an average of 34 employees
for the third quarter ended August 31, 2004 to an average of 43
employees for the third quarter ended August 31, 2005),
- a $199,000 increase in commissions paid to our independent sales
representative firms as a result of increased sales,
- a $186,000 increase in commissions paid to our sales employees,
as a result of hiring additional sales employees in fiscal 2004
and 2005 and increased sales,
- a $185,000 increase in audit-related expenses, primarily as a
result of costs associated with our first internal control
assessment under Section 404 of the Sarbanes-Oxley Act and
related regulations,
- a $109,000 increase in accrued incentive compensation expense due
to our year-to-date 2005 financial performance, primarily
increased sales and net income, in accordance with the 2005
Incentive Compensation Plan,
- a $103,000 increase in travel, training, trade show and
selling-related expenses as a result of our increased sales
personnel and increased sales and marketing efforts, and
- $42,000 in costs for the third quarter of fiscal 2005 associated
with our employer 401(k) matching program, which was implemented
in the fourth quarter of fiscal 2004.
We expect our selling, general and administrative expenses to increase
further in fiscal 2005, primarily as a result of our current plans to hire
additional direct sales personnel in fiscal 2005, increased sales commissions
payable to our direct sales personnel and independent sales representative firms
as sales increase, and increased sales and marketing expenses.
During the third quarter of fiscal 2005, we recognized income tax expense
at an estimated effective tax rate of 34% in our statement of operations, and we
expect this to continue for future periods.
For the three-month period ended August 31, 2005, we realized net income of
$.08 per diluted common share, compared to $.05 per diluted common share for the
third quarter of 2004. The increase in net income per diluted common share is
primarily attributable to
- a 70% increase in net revenues,
- an increase in gross margin percentage to 87% from 86%, and
- a $72,000 increase in interest income.
We achieved the increase in net income despite a 50% increase in operating
expenses and the recognition of income tax expense.
14
SOMANETICS CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
AUGUST 31, 2005
NINE MONTHS ENDED AUGUST 31, 2005 COMPARED TO NINE MONTHS ENDED AUGUST 31, 2004
Our net revenues increased $5,578,597, or 64%, from $8,779,614 in the
nine-month period ended August 31, 2004 to $14,358,211 in the nine-month period
ended August 31, 2005. The increase in net revenues is attributable to
- an increase in United States sales of approximately $4,586,000, or
62%, from approximately $7,390,000 in the first three quarters of
fiscal 2004 to approximately $11,976,000 in the first three quarters
of fiscal 2005. This increase is primarily due to an increase in sales
of the disposable SomaSensor of approximately $3,702,000, or 58%, as a
result of a 39% increase in SomaSensor unit sales and a 13% increase
in SomaSensor average selling prices, and an increase in Cerebral
Oximeter revenues of approximately $960,000, or 165%, due to increased
purchases by pediatric hospitals. This increase was partially offset
by a decrease in sales of the CorRestore System of approximately
$76,000, or 19%, and
- an increase in international sales of approximately $993,000, or 71%,
from approximately $1,389,000 in the first three quarters of fiscal
2004 to approximately $2,382,000 in the first three quarters of fiscal
2005, primarily attributable to increased purchases of the Cerebral
Oximeter and SomaSensor by Tyco Healthcare.
As described above, during the first three quarters of 2005 we achieved a
13% increase in the average selling price of SomaSensors in the United States.
The increase in the average selling price is primarily attributable to the
addition of new customers at our higher suggested retail prices and increased
sales of our pediatric SomaSensor, which sells for a premium price. In addition,
as described above, we had a 39% increase in SomaSensor unit sales in the United
States to 112,257 units. Internationally we sold 42,030 SomaSensors in the first
nine months of 2005.
We placed 216 new Cerebral Oximeters in the United States, and 159
internationally, in the first three quarters of 2005.
Approximately 17% of our net revenues in the first three quarters of fiscal
2005 were from export sales, compared to approximately 16% of our net revenues
in the first three quarters of fiscal 2004. One international distributor
(Europe) accounted for approximately 12% of net revenues for the nine months
ended August 31, 2005.
Sales of our products as a percentage of net revenues were as follows:
PERCENT OF NET REVENUE
FIRST THREE QUARTERS OF FISCAL
------------------------------
PRODUCT 2005 2004
------- ---- ----
SomaSensors.......... 77% 81%
Cerebral Oximeters... 20% 14%
CorRestore Systems... 3% 5%
--- ---
Total............. 100% 100%
=== ===
15
SOMANETICS CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
AUGUST 31, 2005
Gross margin as a percentage of net revenues was approximately 87% for the
nine months ended August 31, 2005 and approximately 83% for the nine months
ended August 31, 2004. The increase in gross margin as a percentage of net
revenues is primarily attributable to the increase in the average selling price
of SomaSensors described above, the reduction in the cost of our SomaSensor by
approximately 40% in May 2004, and increased sales of the Cerebral Oximeter to
pediatric hospitals in the United States.
Our research, development and engineering expenses increased $27,023, or
10%, from $269,418 for the nine months ended August 31, 2004 to $296,441 for the
nine months ended August 31, 2005. The increase is primarily attributable to
development costs associated with the Cerebral Oximeter.
Selling, general and administrative expenses increased approximately
$2,875,000, or 49%, from $5,810,669 for the nine months ended August 31, 2004 to
$8,685,648 for the nine months ended August 31, 2005, primarily due to a 62%
increase in our sales and marketing expenses during the first three quarters of
fiscal 2005 because of our increased sales personnel and our increased sales and
marketing efforts. The increase in selling, general and administrative expense
is primarily attributable to
- a $682,000 increase in salaries, wages, and related expenses,
primarily as a result of an increase in the number of employees,
principally sales and marketing (from an average of 32 employees
for the nine months ended August 31, 2004 to an average of 40
employees for the nine months ended August 31, 2005),
- a $661,000 increase in commissions paid to our sales employees,
as a result of hiring additional sales employees in fiscal 2004
and 2005 and increased sales,
- a $519,000 increase in commissions paid to our independent sales
representative firms as a result of increased sales,
- a $423,000 increase in travel, training, trade show and
selling-related expenses as a result of our increased sales
personnel and increased sales and marketing efforts,
- a $330,000 increase in accrued incentive compensation expense due
to our year-to-date 2005 financial performance, primarily
increased sales and net income, in accordance with the 2005
Incentive Compensation Plan,
- a $255,000 increase in audit-related expenses, primarily as a
result of costs associated with our first internal control
assessment under Section 404 of the Sarbanes-Oxley Act, and
- $118,000 in costs for the first nine months of fiscal 2005
associated with our employer 401(k) matching program, which was
implemented in the fourth quarter of fiscal 2004.
During the first nine months of fiscal 2004 we incurred approximately $96,000 of
expenses as a result of the termination of some of our independent sales
representative firms, and no such expenses were incurred during the first nine
months of fiscal 2005.
During the first nine months of fiscal 2005, we recognized income tax
expense at an estimated effective tax rate of 34% in our statement of
operations.
16
SOMANETICS CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
AUGUST 31, 2005
For the nine-month period ended August 31, 2005, we realized net income of
$.21 per diluted share, compared to $.11 per diluted share in fiscal 2004. This
increased net income per diluted common share is primarily attributable to
- a 64% increase in net revenues,
- an increase in gross margin percentage to 87% from 83%, and
- a $163,000 increase in interest income.
We achieved the increase in net income despite a 48% increase in operating
expenses and the recognition of income tax expense.
LIQUIDITY AND CAPITAL RESOURCES
Net cash provided by operations during the nine-month period ended August
31, 2005 was approximately $3,324,000. Cash was provided by
- net income of approximately $2,448,000, non-cash income tax
expense of approximately $1,261,000, and depreciation and
amortization expense of approximately $277,000,
- an increase in accrued liabilities of approximately $178,000,
primarily due to increased accrued employee sales commissions as
a result of higher sales, increased accrued incentive
compensation as a result of our year-to-date fiscal 2005
financial performance, and increased accrued professional fees
due to costs associated with our first internal control
assessment under Section 404 of the Sarbanes-Oxley Act, partially
offset by payments made in the first nine months for employer
401(k) matching contributions,
- an increase in accounts payable of approximately $117,000,
primarily because of increased inventories, increased sales
commissions payable to our independent representative firms and
partially offset by more timely payments to vendors, and
- a decrease in prepaid expenses of approximately $104,000,
primarily because of the amortization of prepaid insurance
payments made in fiscal 2004.
Cash provided by operations was partially offset by
- an increase in inventories of approximately $627,000 of
SomaSensors and components associated with our Cerebral Oximeter,
and
- an increase in accounts receivable of approximately $442,000,
primarily because of higher third quarter 2005 sales than fourth
quarter 2004 sales, partially offset by faster collection of
receivables in the third quarter of 2005.
The increase in inventories described above is greater than shown on our
balance sheet because it includes Cerebral Oximeters that we capitalized because
they are being used as demonstration units and no-cap sales equipment. We
capitalized approximately $390,000 of costs from inventory for Cerebral
Oximeters being used as demonstration units and no-cap sales equipment at
customer locations during the first nine months of 2005, compared to
approximately $405,000 in the first nine months of fiscal 2004. We depreciate
these assets over five years.
17
SOMANETICS CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
AUGUST 31, 2005
In addition, we had capital expenditures in the first nine months of fiscal
2005 of approximately $120,000. These expenditures were primarily for computer
equipment for our new employees, leasehold improvements to our facility, and
furniture and fixtures associated with the leasehold improvements.
During the first three quarters of fiscal 2005, we issued 273,087 common
shares as a result of stock option exercises, for proceeds of approximately
$1,425,000.
As of August 31, 2005, we had working capital of $14,452,848, cash and cash
equivalents of $11,699,124, total current liabilities of $1,528,081 and
shareholders' equity of $21,432,905. We had an accumulated deficit of
$42,433,891 through August 31, 2005.
For 2005, we expect to realize positive cash flow from operations, as well
as a net increase in cash and cash equivalents, with year-end cash on hand
expected to be approximately $12.5 million.
CRITICAL ACCOUNTING POLICIES
We believe our most significant accounting policies relate to the recording
of an intangible asset for license acquisition costs related to our acquisition
of exclusive, worldwide, royalty-bearing licenses to specified rights relating
to the CorRestore System and related products and accessories, our accounting
treatment of stock options issued to employees, our accounting treatment for
income taxes, and our revenue recognition associated with our no-cap sales
program.
CORRESTORE INTANGIBLE ASSET
In fiscal years 2000, 2001 and 2003, we recorded an intangible asset
related to our acquisition of exclusive, worldwide, royalty-bearing licenses to
specified rights relating to the CorRestore System and related products and
accessories. License acquisition costs included our estimate of the fair value
of ten-year vested stock options to purchase common shares granted to one of our
directors in connection with negotiating and assisting us in completing the
transaction, and our estimate of the fair value of the vested portion of
five-year warrants to purchase common shares issued in the transaction.
Consistent with the treatment of the vested warrants to purchase common shares,
we intend to include in license acquisition costs, and additional paid in
capital, the fair value of the vested portion of the unvested warrants to
purchase common shares, estimated using the Black-Scholes valuation model, when
and if they become vested. However, we do not expect any of these remaining
warrants to become vested before their November 21, 2006 expiration date, based
on sales of CorRestore products to date.
We estimated the value of the stock options to purchase common shares and
the vested warrants to purchase common shares using the Black-Scholes valuation
model. The Black-Scholes valuation model requires the following assumptions:
expected life period of the security, expected volatility of our stock price
during the period, risk-free interest rate, and dividend yield. Given the
assumptions inherent in the Black-Scholes valuation model, it would have been
possible to calculate a different value for our intangible asset by changing one
or more of the valuation model variables or by using a different valuation
model. However, we believe that the model is appropriate, that the judgments and
assumptions that we made at the time of valuation were also appropriate, and
that the reported results would not have been materially different had one or
more of the variables been different or had a different valuation model been
used.
18
SOMANETICS CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
AUGUST 31, 2005
We have adopted Statement of Financial Accounting Standards No. 142,
"Goodwill and Other Intangible Assets." This statement establishes accounting
and reporting standards for goodwill and other intangible assets. The effect of
adopting this Statement has been to discontinue amortizing our license
acquisition costs related to our acquisition of exclusive, worldwide,
royalty-bearing licenses to specified rights relating to the CorRestore System
and related products and accessories described above because we believe these
licenses have an indefinite life. Therefore, we recorded no amortization expense
related to these license acquisition costs in fiscal 2005 or 2004. It is
possible to determine a different life for these licenses, and if they had a
definite life, we would amortize the intangible asset over the remaining useful
life. However, we believe it is appropriate to use an indefinite life for these
licenses. Indefinite lived intangible assets are reviewed annually for
impairment at the end of our fiscal year, and whenever events or changes in
circumstances indicate that the carrying value of the asset may not be
recovered. We evaluate impairment by comparing the fair value of the intangible
asset, determined using a cash flow method, with its carrying value.
EMPLOYEE STOCK OPTIONS
In October 1995, Statement of Financial Accounting Standards No. 123,
"Accounting for Stock-Based Compensation," was issued. In December 2004, the
Financial Accounting Standards Board issued Statement of Financial Accounting
Standards No. 123 (revised), Share Based Payment. This Statement revises
Statement No. 123, "Accounting for Stock-Based Compensation," and requires that
compensation costs related to share-based payment transactions, including stock
options, stock appreciation rights and restricted stock be recognized in the
financial statements. This Statement will be effective for our fiscal quarter
ending February 28, 2006.
We currently account for stock-based compensation of employees using the
intrinsic value method prescribed in Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees," and related interpretations.
Accordingly, compensation costs for stock options granted to employees are
measured as the excess, if any, of the market price of our stock at the date of
the grant over the amount an employee must pay to acquire the stock. No
compensation expense has been charged against income for stock option grants to
employees because our stock option grants are priced at the market value as of
the date of grant. Stock-based compensation of consultants and advisors is
determined based on the fair value of the options or warrants on the grant date
pursuant to the methodology of SFAS No. 123, estimated using the Black-Scholes
model. The resulting amount is recognized as compensation expense and an
increase in additional paid-in capital over the vesting period of the options or
warrants. As a result, we recorded $7,013 of compensation expense, and an equal
increase in additional paid in capital, for stock options issued to
non-employees during the first three quarters of fiscal 2005, and we recorded no
such expense in fiscal 2004. During the first three quarters of fiscal 2005, we
granted 168,257 stock options to our employees, directors and one of our
consultants, and during the first three quarters of fiscal 2004, we granted
50,500 stock options to our employees and directors.
Had we recognized compensation expense for stock options that vested in the
first three quarters of fiscal 2005 and 2004, using the fair value method of
accounting based on the fair value of the options on the grant date using the
Black-Scholes valuation model, our net income, on a pro forma basis, would have
decreased by approximately $1,309,000, or $.11 per diluted common share, and
$567,000, or $.05 per diluted common share, respectively.
19
SOMANETICS CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
AUGUST 31, 2005
INCOME TAXES
During fiscal 2004, we adjusted our deferred tax asset valuation allowance
resulting in the recognition of a deferred tax asset of $6,700,000 related to
the expected future benefits of our net operating loss carryforwards, in
accordance with Statement of Financial Accounting Standards No. 109, "Accounting
for Income Taxes." We have performed the required assessment of positive and
negative evidence regarding realization of our deferred tax assets in accordance
with SFAS No. 109, including our past operating results, the existence of
cumulative losses over our history up to the most recent two fiscal years, and
our forecast for future net income. The primary assumption underlying our
determination that the net asset will be realized is that our revenues and
pre-tax income will grow in future years consistent with the original growth
guidance given for fiscal 2005. Our assessment of our deferred tax assets, and
the reversal of part of our valuation allowance, included evaluating our
financial plans and our future projected earnings, making allowance for the
uncertainties surrounding, among other things, our future rate of growth in net
revenues, the rate of adoption of our products in the marketplace, and the
potential for competition to enter the marketplace.
In reversing a portion of our valuation allowance, we have concluded that
it is more likely than not that such assets will be realized. Given the
assumptions inherent in our financial plans, it is possible to calculate a
different value for our deferred tax asset by changing one or more of the
variables in our assessment. However, we believe that our evaluation of our
financial plans was reasonable, and that the judgments and assumptions that we
made at the time of developing the plan were appropriate.
During the first quarter of fiscal 2005, we began recognizing income tax
expense at an estimated effective tax rate of 34% on our statement of
operations. As we assess our plans for future years, we will continue to review
the appropriateness of adjusting our deferred tax asset valuation allowance and
recognizing additional net deferred tax assets.
NO-CAP SALES REVENUE RECOGNITION
We offer to our customers in the United States a no-cap sales program
whereby we ship the Cerebral Oximeter to the customer at no charge, in exchange
for the customer agreeing to purchase SomaSensors. We recognize SomaSensor
revenue when we receive purchase orders and ship the product to the customer.
Under our no-cap sales program, we do not recognize any revenue upon the initial
shipment of the Cerebral Oximeter. At the time of shipment, we capitalize the
Cerebral Oximeter as an asset and depreciate this asset over five years. We
believe this is consistent with our stated revenue recognition policy, which is
compliant with Staff Accounting Bulletin No. 104 and Emerging Issues Task Force
No. 00-21, "Revenue Arrangements with Multiple Deliverables."
20
SOMANETICS CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
AUGUST 31, 2005
CONTRACTUAL OBLIGATIONS
As of August 31, 2005, there have been no material changes outside the
ordinary course of business in the contractual obligations disclosed in our
Annual Report on Form 10-K for the fiscal year ended November 30, 2004 under the
caption "Contractual Obligations".
21
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable.
22
ITEM 4. CONTROLS AND PROCEDURES
Our management has evaluated, with the participation of our principal
executive and principal financial officers, the effectiveness of our disclosure
controls and procedures as of August 31, 2005, and, based on their evaluation,
our principal executive and principal financial officers have concluded that
these controls and procedures are effective as of August 31, 2005. There was no
change in our internal control over financial reporting identified in connection
with such evaluation that occurred during our third fiscal quarter ended August
31, 2005 that has materially affected, or is reasonably likely to materially
affect, our internal control over financial reporting.
Disclosure controls and procedures are our controls and other procedures
that are designed to ensure that information required to be disclosed by us in
the reports that we file or submit under the Exchange Act is recorded,
processed, summarized and reported, within the time periods specified in the
Securities and Exchange Commission's rules and forms. Disclosure controls and
procedures include, without limitation, controls and procedures designed to
ensure that information required to be disclosed by us in the reports that we
file or submit under the Exchange Act is accumulated and communicated to our
management, including our principal executive and principal financial officers,
as appropriate to allow timely decisions regarding required disclosure.
23
PART II OTHER INFORMATION
ITEM 6. EXHIBITS
31.1 Certifications of Chief Executive Officer Pursuant to Rule 13a-14(a), as
Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2 Certifications of Chief Financial Officer Pursuant to Rule 13a-14(a), as
Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1 Certifications 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.
24
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.
Somanetics Corporation
(Registrant)
Date: October 12, 2005 By: /s/ William M. Iacona
------------------------------------
William M. Iacona
Vice President, Finance, Controller, and
Treasurer (Duly Authorized and
Principal Financial Officer)
25
EXHIBIT INDEX
Exhibit Description
------- -----------
31.1 Certifications of Chief Executive Officer Pursuant to Rule 13a-14(a),
as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2 Certifications of Chief Financial Officer Pursuant to Rule 13a-14(a),
as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1 Certifications 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.
26