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BSD MEDICAL CORP - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) This Management's Discussion and Analysis of Financial Condition and Results of Operations and other parts of this report contain forward-looking statements that involve risks and uncertainties. Forward-looking statements can also be identified by words such as "anticipates," "expects," "believes," "plans," "predicts," and similar terms. Forward-looking statements are not guarantees of future performance and our actual results may differ significantly from the results discussed in the forward-looking statements. Factors that might cause such differences include, but are not limited to, those discussed in the subsection entitled "Forward-Looking Statements" below. The following discussion should be read in conjunction with our financial statements and notes thereto included in this report. We assume no obligation to revise or update any forward-looking statements for any reason, except as required by law. Overview We develop, manufacture, market, and service systems to treat cancer and benign diseases using heat therapy delivered using focused microwave and radiofrequency ("RF") energy. Our product lines include both hyperthermia and ablation treatment systems. Backlog As of July 13, 2011, the Company had a sales backlog of $270,000, consisting of hyperthermia systems. The timing of reporting the sales for these systems will depend on the delivery of the systems to the customers, collection of the sales price and other revenue recognition criteria. In some instances, this process could require a number of months. MicroThermX® Microwave Ablation System Our MicroThermX® Microwave Ablation System ("MicroThermX®") is a compact, mobile, state-of-the-art, proprietary system that includes a microwave generator, single-patient-use disposable antennas, and a thermistor-based temperature monitoring system. The innovative design of the MicroThermX® is the first of its kind that allows delivery of higher power levels using a single generator. The MicroThermX® utilizes proprietary synchronous phased array technology that was developed and patented by us to provide larger and more uniform zones of ablation during a single procedure. The MicroThermX® introduces into our product line a high-end disposable antenna that is used in each ablation treatment, which we believe represents the potential for a significant ongoing revenue stream after the sale of the system. In August 2010, the U.S. Food and Drug Administration ("FDA") granted us a 510(k) clearance to market the MicroThermX® for ablation of soft tissue. Clearance from the FDA of the 510(k) Premarket Notification submission authorizes the commercial sale of the MicroThermX® in the United States. We have also received CE Marking for the MicroThermX®, which allows us to market the MicroThermX® in the thirty countries that comprise the European Union ("EU") and the European Free Trade Association ("EFTA"). CE Marking is also recognized in many countries outside of the EU, providing us the ability to market the MicroThermX® to a number of international markets. After increasing production capacity, completing placement of systems in key hospitals, and witnessing early clinical successes, we have signed geographically exclusive distribution agreements for the MicroThermX® product line with four domestic specialty distribution firms. This completes our strategic initiative to capitalize on the large ablation market by establishing an exclusive, specialty distribution network that will provide nationwide sales coverage for the MicroThermX® line of products. Distributors have been selected based on their sales record, their synergistic product mix, and their focus in the field of interventional oncology/radiology, the target market for our ablation product line. 13 -------------------------------------------------------------------------------- To support the global distribution network for the MicroThermX® product line, we have increased our marketing and sales staff, including additional Regional Sales Management. We believe that increasing MicroThermX® marketing and sales resources to support our existing management team is key to making the strategic decision to utilize specialty distribution firms a success. We believe additional marketing and sales resources will provide hands-on field training and management of the distribution network. We further believe the sales and distribution network that is now in place will ensure that trained sales representatives are presenting the advantages of the MicroThermX® to interventional oncologists throughout the United States. The increased sales activity has resulted in a full schedule of clinical evaluations over the coming weeks. These evaluations represent an important milestone in the MicroThermX® sales cycle, with hospital capital budgeting, committee review and other approvals required to complete the sales cycle. The evaluations have led to an increase in the number of sites that may decide to purchase equipment following clinical evaluations. We have met with over forty international distribution firms and have started contract negotiations with select European based firms. We anticipate visiting the headquarters of these specialty distribution firms in the coming weeks to finalize contract negotiations and begin training of international distributor sales representatives. In January 2011, we announced the sale and shipment of the first MicroThermX® to one of the largest interventional radiology/oncology distributors in Italy, and we anticipate additional international shipments of the MicroThermX® and supplies of disposable antennas later in calendar year 2011. The medical facilities where we initially placed MicroThermX® systems continue to reorder disposable microwave antennas, providing early validation of the potential ongoing revenue stream we anticipate. In addition, existing users of the MicroThermX® are reporting positive clinical results in the treatment of tumors. Our Italian distributor continues to report more cases performed with the MicroThermX®, having equally good clinical results. The distributor is co-sponsoring with us clinical trials that are anticipated to start in the next fiscal quarter. Hyperthermia Systems Our hyperthermia cancer treatment systems, which have been in use for several years in the United States, Europe and Asia, are used to treat certain tumors with heat (hyperthermia) while increasing the effectiveness of other therapies such as radiation therapy. We have developed extensive intellectual property, multiple products in the market and established distribution in the United States, Europe and Asia. Certain of our hyperthermia systems have received regulatory approvals and clearances in the United States, Europe and China. BSD-500. Our BSD-500 Hyperthermia System, or the BSD-500, is used to deliver either superficial hyperthermia therapy, which is non-invasive and delivered externally using antennae placed over the tumor, or interstitial hyperthermia therapy, which is delivered using antennae that are inserted into the tumor, or both. These systems consist of four major subsystems: a microwave power generator delivery subsystem; a proprietary, thermistor-based, thermometry subsystem; a computerized monitoring and control subsystem; and an applicator subsystem. These systems include a touch screen display monitor by which the operator controls the hyperthermia treatment, computer equipment and software that controls the delivery of microwave energy to the tumor, and a generator that creates the needed microwave energy for the treatment. Additionally, the systems include a variety of applicator (radiating antennae) configurations, depending on the system. Various configurations of non-invasive applicators (antennae) are used for superficial hyperthermia treatments. For interstitial hyperthermia treatments, the system may include up to 24 small microwave heat-delivering antennae that are inserted into catheters used for internal radiation therapy (called brachytherapy). 14 -------------------------------------------------------------------------------- Our primary FDA approval (described as a pre-market approval, or "PMA", which is the standard FDA approval required to market Class III medical devices in the United States) for the BSD-500 is for the use of hyperthermia and radiation therapy to treat certain tumors using the BSD-500. There are some clinical studies that have been published that show the effectiveness and safety for the use of hyperthermia and certain chemotherapy drugs for the treatment of some cancers. However, we do not currently have FDA approval in the US for the use of hyperthermia in conjunction with chemotherapy. Physicians are allowed to utilize medical devices that have been approved or cleared by the FDA, including the BSD-500, for off label indications (indications for use that are not included in the FDA approval or clearance), but a manufacturer cannot promote for an off label use in the United States, as the FDA considers this to be an unproven clinical application. We have received FDA approval through FDA supplements for implementation of a new operating system and a new power generation system and other commercial upgrades for the BSD-500 configurations. We have also certified the BSD-500 systems for the CE Mark, which is required for export into some European and non-European countries. BSD-2000. The BSD-2000 Hyperthermia System, or the BSD-2000, family of products includes the BSD-2000, the BSD-2000/3D and the BSD-2000/3D/MR. These systems non-invasively deliver localized therapeutic heating (hyperthermia) to solid tumors by applying radiofrequency (RF) energy to certain cancerous tumors, including those located deep within the body. These systems consist of four major subsystems: an RF power generator delivery subsystem; a proprietary, thermistor-based, thermometry subsystem; a computerized monitoring and control subsystem; and an applicator subsystem that includes an applicator and patient support system; as well as various accessories. The BSD-2000 delivers energy to a patient using a power source and an array of multiple antennae that surround the patient's body. The BSD-2000 systems create a central focusing of energy that can be adjusted to target the 3-dimensional shape, size, and location of the tumor, thus providing dynamic control of the heating delivered to the tumor region. The basic BSD-2000 has eight microwave antennae enabling this electronic steering of energy within the patient's body. The BSD-2000/3D has 24 microwave antennae enabling additional electronic steering along the long axis of the body. The 3D steering is particularly useful when implemented with a magnetic resonance system that is capable of non-invasive 3D imaging showing the heated regions, thus permitting the clinician to view the heating pattern in the tumor and steer the energy to the tumor site. The BSD-2000 has not yet received approval from the FDA for commercial marketing in the United States, but the BSD-2000 has obtained an investigational device exemption, or IDE, for placement in the United States for research purposes only. We have also certified the BSD-2000 family for the CE Mark required for export into certain European and non-European countries and have obtained regulatory approval for the sale of the BSD-2000 in the People's Republic of China. In March 2006, we filed an FDA submission requesting PMA for the BSD-2000. During the PMA review process, we worked closely with the FDA to determine an appropriate pathway to obtain a marketing approval for the BSD-2000 utilizing the clinical data that was available to us to support marketing approval. During this process, the FDA suggested that the Humanitarian Device Exemption ("HDE") marketing approval process might be the most expeditious pathway for us to obtain marketing approval. On May 18, 2009, the FDA granted Humanitarian Use Device ("HUD") designation for our BSD-2000 for use in conjunction with radiation therapy for the treatment of cervical carcinoma patients who are ineligible for chemotherapy. This is the first of the two steps required to obtain HDE marketing approval. Subsequent to the FDA granting the HUD for the BSD-2000, which confirms that the intended use population is fewer than 4,000 patients per year, we filed an HDE submission with the FDA. As of the date of filing this report, the FDA continues its review of our HDE marketing submission for the BSD-2000. We are unable to predict when the review process will be completed and its ultimate outcome. If we are unable to receive HDE marketing approval, or if the FDA requires us to undergo extensive testing in order to grant HDE marketing approval, our business might be adversely affected. 15 -------------------------------------------------------------------------------- The PMA was placed on hold until the HUD designation was granted by the FDA. Once the HUD designation was granted and the HDE was filed, per FDA regulations, we withdrew the PMA submission. We can decide to pursue PMA for the BSD-2000 at a future date. The HDE approval of the BSD-2000 will authorize the commercial sale of the BSD-2000 in the United States. However, there are some differences between the HDE marketing approval and PMA approval, as well as some limitations on the HDE approved devices. The HDE approval demonstrates safety and probable benefit, is intended for use in the treatment of a disease that affects fewer than 4,000 individuals in the United States per year, is only granted when no comparable device has been approved to treat the same disease population, and requires approval from an Institutional Review Board before being used in a facility. In addition, we cannot charge an amount for an HDE approved device that exceeds the costs of research and development, fabrication, and distribution. A device can have both PMA and an HDE approval as long as the approvals are for different indications for use. In addition, a product can have multiple HDE approvals for different applications, and we may decide to pursue additional HDE approvals for the BSD-2000 in the future. BSD-2000/3D. Through research funded by the National Cancer Institute in the United States and supportive efforts by other domestic and international research institutions, we enhanced the BSD-2000 to create the BSD-2000/3D. The BSD-2000/3D adds three-dimensional steering of deep focused energy, enabling additional electronic steering along the long axis of the body. As part of our international collaborative research efforts, sophisticated treatment planning software for the BSD-2000/3D has also been developed. We have not yet submitted to the FDA a marketing application for the BSD-2000/3D. However, we have obtained the CE Mark necessary to export the BSD-2000/3D to certain European countries and other countries requiring CE Mark certification. BSD-2000/3D/MR. As a further enhancement of the BSD-2000/3D, we have added to it the option of concurrent magnetic resonance imaging, or MRI, used for monitoring the delivery of deep hyperthermia therapy. Using sophisticated microwave filtering and imaging software, the BSD-2000/3D/MR allows an MRI system to be interfaced with and operate simultaneously with a BSD-2000/3D. The development of MRI treatment monitoring is a significant breakthrough in the development of hyperthermic oncology primarily because it allows non-invasive "on-line" review of hyperthermic treatment progress and quantifies and documents the benefit and safety of hyperthermia treatment. We installed and tested the first BSD-2000/3D/MR system at a leading German oncological research institution, the Clinic of Medical Oncology of the Klinikum Großhadern Medical School of Ludwigs-Maximilians-Universität München, in Munich, Germany. We have since installed BSD-2000/3D/MR systems at multiple other locations. As is the case for the BSD-2000/3D, we have not yet submitted to the FDA a marketing application for the BSD-2000/3D/MR. We can, however, market the BSD-2000/3D/MR in Europe as we have CE Mark approval for the BSD-2000/3D/MR, provided we interface the system with an MRI system that also is approved in Europe. 16 -------------------------------------------------------------------------------- Results of Operations Fluctuation in Operating Results Our results of operations have fluctuated in the past and may fluctuate in the future from year to year as well as from quarter to quarter. Revenue may fluctuate as a result of factors relating to the demand and market acceptance for our hyperthermia systems and related component parts and services, world-wide economic conditions, availability of financing for our customers, changes in the medical capital equipment market, changes in order mix and product order configurations, competition, regulatory developments and other matters. Operating expenses may fluctuate as a result of the timing of sales and marketing activities, research and development, and general and administrative expenses associated with our potential growth. For these and other reasons described elsewhere, our results of operations for a particular period may not be indicative of operating results for any other period. With the decrease in our revenues in our fiscal year ended August 31, 2010 compared to the prior fiscal year, primarily as a result of the decrease in sales of our hyperthermia systems, we implemented expense reduction measures to reduce the level of our monthly operating cash burn, including an employee reduction and reduction in the level of involvement of certain key outside consultants. With this reduction in force, we closed a satellite office in Arizona and also reduced other operating expenses such as payroll taxes, employee benefits and travel. To continue the roll out of the MicroThermX® product line and to support its global distribution network, we have increased our marketing and sales staff and incurred additional marketing, sales and related operating expenses. We believe, therefore, that the level of our operating expenses may increase over the level reported for the three months and nine months ended May 31, 2011, and the increase may be significant. Revenues Through May 31, 2011, most of our operating revenues have been from the sale of our hyperthermia cancer systems. We recognize revenue from the sale of our hyperthermia cancer treatment systems and related parts and accessories (collectively, "product sales"), the sale of consumable devices used with certain of our systems, training, service support contracts and other miscellaneous revenues. During the three months and nine months ended May 31, 2011, we received equipment rental income from an operating lease for a hyperthermia system. Our revenues can fluctuate significantly from period to period because our sales, to date, have been based upon a relatively small number of hyperthermia systems, the sales price of each being substantial enough to greatly impact revenue levels in the periods in which they occur. Sales of a few hyperthermia systems, particularly BSD-2000/3D/MR systems, can cause a large change in our revenues from period to period and the sales cycle for our systems generally extends over multiple financial reporting periods. In addition, differences in the configuration of the hyperthermia systems sold, pricing, and other factors can result in significant differences in the sales price per system and in the total revenues reported in a given period. As a result, there may be quarterly financial reporting periods where we may report no or minimal revenues from the sale of hyperthermia systems. To date, hyperthermia therapy has not gained wide acceptance by cancer-treating physicians. We believe this is due in part to the lingering impression created by the inability of early hyperthermia therapy technologies to focus and control heat directed at specific tissue locations and inaccurate conclusions drawn in early scientific studies that hyperthermia was only marginally effective. Additionally, we do not believe that reimbursement rates from third-party payers have been adequate to promote hyperthermia therapy acceptance in the medical community. 17 -------------------------------------------------------------------------------- We also believe the continuing worldwide economic downturn has made it difficult for many of our customers to obtain approval for the purchase of our hyperthermia systems and to arrange related financing. Political, economic and regulatory influences are subjecting the U.S. healthcare industry to fundamental changes. We may continue to face significant uncertainty in the industry due to recent governmental healthcare reform. We believe the uncertainties regarding the ultimate features of reform initiatives and their enactment and implementation may also have an adverse effect on our customers' purchasing decisions regarding our products and services. In January 2011, we sold our first MicroThermX® to a customer in Italy. We had no other sales of the MicroThermX® through May 31, 2011. The MicroThermX® product line represents a major part of our business plan moving forward, and we believe the growth in our revenues and our ultimate profitability will be largely dependent on the success of our MicroThermX® sales and marketing efforts. In addition, as discussed above, the MicroThermX® introduces into our product line a disposable antenna used in each treatment, which we believe represents the potential for a significant ongoing revenue stream after the sale of the system. However, we cannot be sure that revenues from the MicroThermX® family of products will be consistent with our expectations. The following table summarizes the number of systems sold for the three months and nine months ended May 31, 2011 and 2010: Three Months Ended Nine Months Ended May 31, May 31, 2011 2010 2011 2010 MicroThermX® - - 1 - Hyperthermia Systems: BSD-500 1 - 3 2 BSD-2000 1 - 2 2 BSD-2000/3D - - - - BSD-2000/3D/MR 1 - 1 - Total Hyperthermia Systems 3 - 6 4 Our sales to related parties are comprised of the sale of hyperthermia systems and related component parts and services sold to Medizin-Technik GmbH and Dr. Gerhard Sennewald. Dr. Sennewald, one of our directors and significant stockholders, is a stockholder, executive officer and a director of Medizin-Technik GmbH. At times, these related party sales represent a significant portion of our revenues. We derived $1,017,845, or approximately 61%, of our total revenues in the three months ended May 31, 2011 from sales to related parties, compared to $59,371, or approximately 48%, in the three months ended May 31, 2010. We derived $1,058,597, or approximately 40%, of our total revenues in the nine months ended May 31, 2011 from sales to related parties, compared to $226,305, or approximately 20%, in the nine months ended May 31, 2010. We had no sales of hyperthermia systems to related parties in the three months or nine months ended May 31, 2010. 18 -------------------------------------------------------------------------------- The following tables summarize the sources of our sales for the three months and nine months ended May 31, 2011 and 2010: Three Months Ended Nine Months Ended May 31, May 31, Non-Related Parties 2011 2010 2011 2010 Product sales $ 550,000 $ - $ 1,316,350 $ 795,440 Consumable devices 50,544 6,900 51,144 11,100 Service contracts 37,292 42,543 110,672 95,349 Other 9,896 14,788 28,738 21,685 Total $ 647,732 $ 64,231 $ 1,506,904 $ 923,574 Related Parties Product sales $ 1,010,687 $ 55,875 $ 1,011,587 $ 166,050 Consumable devices 900 - 28,650 16,500 Other 6,258 3,496 18,360 43,755 Total $ 1,017,845 $ 59,371 $ 1,058,597 $ 226,305 During the three months and nine months ended May 31, 2011, we had $9,900 and $61,400 of equipment rental revenues from an operating lease of a BSD-500 to one customer. We had no such equipment rental revenues in the three months and nine months ended May 31, 2010. Total revenues for the three months ended May 31, 2011 were $1,675,477 compared to $123,602 for the three months ended May 31, 2010, an increase of $1,551,875. Total revenues for the nine months ended May 31, 2011 were $2,626,901 compared to $1,149,879 for the nine months ended May 31, 2010, an increase of $1,477,022. On a year-to-date basis, total revenues increased approximately 128% over total revenues for the same nine-month period in the prior fiscal year. The increase in revenues in the three months and nine months ended May 31, 2011 is due primarily to the sale of more hyperthermia systems, including a BSD-2000 3D/MR, and the addition of equipment rental revenues. Cost of Revenues Cost of sales includes raw material, labor and allocated overhead costs. We calculate and report separately cost of sales for both non-related and related party sales, which are sales to Medizin-Technik and Dr. Sennewald. Cost of sales as a percentage of sales will fluctuate from period to period depending on the mix of sales for the period and the type and configuration of the hyperthermia systems sold during the period. Cost of equipment rental includes installation, training, maintenance and support costs and depreciation of rental equipment. Total cost of revenues for the three months ended May 31, 2011 was $641,438 compared to $346,941 for the three months ended May 31, 2010, an increase of $294,497, or approximately 85%. Total cost of revenues for the nine months ended May 31, 2011 was $1,407,104 compared to $1,252,918 for the nine months ended May 31, 2010, an increase of $154,186, or approximately 12%. This increase resulted primarily from increased sales of hyperthermia systems and the addition of cost of equipment rental in the current fiscal year. 19 -------------------------------------------------------------------------------- Gross Margin Our gross margin and gross margin percentage will fluctuate from period to period depending on revenue levels and the mix of revenues reported for the period and the type and configuration of the hyperthermia systems sold during the period. Our total gross margin was $1,034,039, or approximately 62% of total revenues, for the three months ended May 31, 2011 and $1,219,797, or approximately 46% of total revenues for the nine months ended May 31, 2011. By comparison, our total gross margin was $(223,339) and $(103,039) for the three months and nine months ended May 31, 2010, respectively. The increase in gross margin and gross margin percentage in the current fiscal year resulted primarily from increased sales of hyperthermia systems and the gross margin contributed by our equipment rental. Operating Costs and Expenses Research and Development Expenses - Research and development expenses include expenditures for new product development and development of enhancements to existing products. Our research and development expenses for the nine months ended May 31, 2011 have been offset by the $488,958 proceeds from two separate U.S. government grants under the QTDP Program received in our first fiscal quarter ended November 30, 2010. Research and development expenses were $481,994 for the three months ended May 31, 2011 compared to $795,294 for the three months ended May 31, 2010, a decrease of $313,300, or approximately 39%. Research and development expenses were $992,110 for the nine months ended May 31, 2011 compared to $1,959,922 for the nine months ended May 31, 2010, a decrease of $967,812, or approximately 49%. In addition to the offset of the QTDP grants in the first quarter ended November 30, 2011, research and development expenses decreased in the current fiscal year primarily from the shift from product development activities to sales and marketing efforts for the MicroThermX® product line, and due to our operating expense reduction measures. Selling, General and Administrative Expenses - Selling, general and administrative expenses were $1,389,175 for the three months ended May 31, 2011 compared to $1,371,673 for the three months ended May 31, 2010, an increase of $17,502, or approximately 1%. Selling, general and administrative expenses were $3,589,573 for the nine months ended May 31, 2011 compared to $4,207,412 for the nine months ended May 31, 2010, a decrease of $617,839, or approximately 15%. The decrease in selling, general and administrative expenses on a year-to-date basis in the current fiscal year is due to the headcount reductions and other operating expense reduction measures implemented in the latter part of last fiscal year. As discussed above, however, as we continue the roll out of the MicroThermX® product line and the support of its global distribution network, we have increased our marketing and sales staff, including three regional sales managers, a director of marketing and a customer service manager, and incurred additional marketing, sales and related operating expenses. As a result, we incurred an increase in our selling, general and administrative expenses for the three months ended May 31, 2011. We believe that the level of our selling, general and administrative expenses will continue to increase over the levels reported for the three months and nine months ended May 31, 2011, and the increase may be significant. Other Income (Expense) During the three months and nine months ended May 31, 2011 and 2010, our other income (expense) was not material to our operations. Liquidity and Capital Resources Since inception through May 31, 2011, we have generated an accumulated deficit of $27,449,876. Generally, our operating revenues have been insufficient to cover our operating expenses. We have financed our operations primarily through the sale of an investment in a spinoff operation and the issuance of our common stock and warrants. As of May 31, 2011, we had cash and cash equivalents of $18,573,270, comprised primarily of money market funds. 20 -------------------------------------------------------------------------------- As of May 31, 2011, we had current liabilities totaling $675,117, comprised of accounts payable, accrued liabilities, customer deposits and deferred revenue incurred in the normal course of our business. Our long-term liabilities consisted of deferred revenue of $78,238. Stock Offerings On October 1, 2009, our universal shelf registration statement was declared effective by the SEC for the issuance of common stock, preferred stock, warrants, senior debt, subordinated debt and units up to an aggregate amount of $50.0 million. We may periodically offer one or more of these securities in amounts, prices and on terms to be announced when and if the securities are offered. At the time any of the securities covered by the registration statement are offered for sale, a prospectus supplement will be prepared and filed with the SEC containing specific information about the terms of any such offering. In February, May and August 2010 we completed three stock offerings with institutional investors utilizing our shelf registration statement whereby we received total proceeds, net of offering costs, of approximately $6.5 million. November 2010 Stock Offering On November 15, 2010, we entered into the November Agency Agreement with the Placement Agent, pursuant to which the Placement Agent agreed to use its reasonable efforts to arrange for the sale of up to 1,750,000 shares of our common stock and warrants to purchase up to 875,000 shares of our common stock in a registered direct public offering. The Placement Agent was entitled to a cash fee of 6.5% of the gross proceeds paid to us for the securities we would sell in the November Offering. We would also reimburse the Placement Agent for all reasonable and documented out-of-pocket expenses that have been incurred by the Placement Agent in connection with the November Offering, which could not exceed the lesser of (i) $30,000 or (ii) 8% of the gross proceeds of the November Offering, less the Placement Agent's placement fee. The November Agency Agreement contains customary representations, warranties and covenants by us. It also provides for customary indemnification by us and the Placement Agent for losses or damages arising out of or in connection with the sale of the securities being offered. We agreed to indemnify the Placement Agent against liabilities under the Securities Act of 1933, as amended. We also agreed to contribute to payments the Placement Agent may be required to make in respect of such liabilities. Also on November 15, 2010, we and certain institutional investors entered into the November Purchase Agreement in connection with the November Offering, pursuant to which we agreed to sell an aggregate of 1,750,000 shares of our common stock and warrants to purchase a total of 875,000 shares of our common stock to such investors for aggregate gross proceeds, before deducting fees to the Placement Agent and other estimated offering expenses payable by us, of approximately $10.45 million. The common stock and warrants were sold in fixed combinations, with each combination consisting of one share of common stock and a warrant to purchase 0.50 shares of common stock. The purchase price was $5.97 per fixed combination. The warrants will become exercisable six months and one day following the closing date of the November Offering and will remain exercisable for five years thereafter at an exercise price of $7.73 per share. The exercise price of the warrants is subject to adjustment in the case of stock splits, stock dividends, combinations of shares and similar recapitalization transactions. The exercisability of the warrants may be limited if, upon exercise, the holder or any of its affiliates would beneficially own more than 4.9% of our common stock. 21 -------------------------------------------------------------------------------- We agreed with each of the purchasers that while the warrants are outstanding, we will not affect or enter into an agreement to affect a Variable Rate Transaction, which means a transaction in which we: · issue or sell any convertible securities either (A) at a conversion, exercise or exchange rate or other price that is based upon and/or varies with the trading prices of, or quotations for, the shares of our common stock at any time after the initial issuance of such convertible securities, or (B) with a conversion, exercise or exchange price that is subject to being reset at some future date after the initial issuance of such convertible securities or upon the occurrence of specified or contingent events directly or indirectly related to our business or the market for our common stock, other than pursuant to a customary "weighted average" anti-dilution provision; or · enter into any agreement (including, without limitation, an equity line of credit) whereby we may sell securities at a future determined price (other than standard and customary "preemptive" or "participation" rights). We agreed with each of the purchasers that if we issue securities within the 12 months following the closing of the November Offering, the purchasers shall have the right to purchase all of the securities on the same terms, conditions and price provided for in the proposed issuance of securities. We agreed to indemnify each of the purchasers against certain losses resulting from our breach of any of our representations, warranties, or covenants under agreements with each of the purchasers, as well as under certain other circumstances described in the November Purchase Agreement. We closed the November Offering on November 18, 2010. The net proceeds to us from the November Offering, after deducting placement agent fees and the offering expenses borne by us, were approximately $9.7 million. The November Offering was completed using our shelf registration statement on Form S-3, pursuant to a prospectus supplement filed with the SEC. Warrants During the nine months ended May 31, 2011, investors exercised warrants to purchase a total of 1,501,134 common shares, with net proceeds to the Company of approximately $3.0 million. Cash Flows from Operating, Investing and Financing Activities During the nine months ended May 31, 2011, we used net cash of $2,684,443 in operating activities, primarily as a result of our net loss of $3,318,806, decreased by non-cash expenses totaling $990,077, including depreciation and amortization, stock-based compensation and stock issued for services. Net cash used in operating activities also included increases in receivables of $700,504 and other current assets of $5,859 and a decrease in deferred revenue of $26,185, partially offset by decreases in income tax receivable of $50,000 and inventories of $131,238, and increases in accounts payable of $99,372, accrued liabilities of $71,224, and customer deposits of $25,000. During the nine months ended May 31, 2010, we used net cash of $4,187,804 in operating activities, primarily as a result of our net loss of $6,254,295, decreased by non cash expenses of $1,021,027, including depreciation and amortization, stock-based compensation and stock issued for services. Net cash used in operating activities also included increases in inventories of $356,183 and other current assets of $81,168 and a decrease of accrued liabilities of $310,706, partially offset by decreases in receivables of $209,421 and income tax receivable of $1,365,758 and increases in accounts payable of $192,766 and deferred revenue of $25,576. 22 -------------------------------------------------------------------------------- Net cash used in investing activities for the nine months ended May 31, 2011 and 2010 was $174,035 and $111,432, respectively, resulting from the purchase of property and equipment. Net cash provided by financing activities for the nine months ended May 31, 2011 was $12,948,183, comprised of net proceeds from the sale of common stock of $9,702,656, proceeds from the exercise of warrants of $2,989,407 and proceeds from the exercise of stock options of $256,120. Net cash provided by financing activities for the nine months ended May 31, 2010 was $3,987,549, comprised of net proceeds from the sale of common stock. We believe that our current cash and cash equivalents will be sufficient to fund our operations for the next twelve months. As of May 31, 2011, we had no significant commitments for the purchase of property and equipment. We had no material off balance sheet arrangements as of May 31, 2011. Other Cash Receipts In November 2010, we were awarded two separate U.S. government grants under the QTDP Program. We submitted grant applications for our BSD-2000 and our MicroThermX® and both applications were approved for the maximum award for a single program of $244,479, or a total of $488,958. In order to qualify for the QTDP grants, the project must have the potential to develop new treatments that address "unmet medical needs" or chronic and acute diseases; reduce long-term health care costs; represent a significant advance in finding a cure for cancer; advance U.S. competitiveness in the fields of life, biological, and medical sciences; or create or sustain well-paying jobs, either directly or indirectly. The QTDP was created by Congress in March 2010 as part of the Patient Protection and Affordable Care Act and provides a tax credit or a grant equal to 50% of eligible costs and expenses for tax years 2009 and 2010. Critical Accounting Policies The following is a discussion of our critical accounting policies and estimates that management believes are material to an understanding of our results of operations and which involve the exercise of judgment or estimates by management. Revenue Recognition: Revenue from the sale of cancer treatment systems is recognized when a purchase order has been received, the system has been shipped, the selling price is fixed or determinable, and collection is reasonably assured. Most system sales are F.O.B. shipping point; therefore, shipment is deemed to have occurred when the product is delivered to the transportation carrier. Most system sales do not include installation. If installation is included as part of the contract, revenue is not recognized until installation has occurred, or until any remaining installation obligation is deemed to be perfunctory. Some sales of systems may include training as part of the sale. In such cases, the portion of the revenue related to the training, calculated based on the amount charged for training on a stand-alone basis, is deferred and recognized when the training has been provided. The sales of our cancer treatment systems do not require specific customer acceptance provisions and do not include the right of return except in cases where the product does not function as warranted by us. To date, returns have not been significant. Revenue from the sale of consumable devices is recognized when a purchase order has been received, the devices have been shipped, the selling price is fixed or determinable, and collection is reasonably assured. Currently, our customers are not required to purchase a minimum number of disposable devices in connection with the purchase of our systems. 23 -------------------------------------------------------------------------------- Revenue from training services is recorded when an agreement with the customer exists for such training, the training services have been provided, and collection is reasonably assured. Revenue from service support contracts is recognized on a straight-line basis over the term of the contract, which approximates recognizing it as it is earned. Revenue from equipment rental under an operating lease is recognized when billed in accordance with the lease agreement. Our revenue recognition policy is the same for sales to both related parties and non-related parties. We provide the same products and services under the same terms for non-related parties as with related parties. Sales to distributors are recognized in the same manner as sales to end-user customers. Deferred revenue and customer deposits payable include amounts from service contracts as well as cash received for the sales of products, which have not been shipped. Inventory Reserves: We maintain a reserve for obsolete inventories to reduce excess and obsolete inventories to their estimated net realizable value. This reserve is a significant estimate and we periodically review our inventory levels and usage, paying particular attention to slower-moving items. If projected sales do not materialize or if our hyperthermia systems do not receive increased market acceptance, we may be required to increase the reserve for obsolete inventories in future periods. Product Warranty: We provide product warranties on our systems. These warranties vary from contract to contract, but generally consist of parts and labor warranties for one year from the date of installation. To date, expenses resulting from such warranties have not been material. We record a warranty expense at the time of each sale. This reserve is estimated based on prior history of service expense associated with similar units sold in the past. Allowance for Doubtful Accounts: We maintain an allowance for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. This allowance is a significant estimate and is regularly evaluated by us for adequacy by taking into consideration factors such as past experience, credit quality of the customer base, age of the receivable balances, both individually and in the aggregate, and current economic conditions that may affect a customer's ability to pay. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required. Stock-based Compensation: Stock-based compensation, consisting of the cost of stock options and other stock-based awards to employees and directors, is measured at the grant date based on the estimated value of the award granted, using the Black-Scholes option pricing model, and recognized over the period in which the award vests. For stock awards no longer expected to vest, any previously recognized stock compensation expense is reversed in the period of termination. The stock-based compensation expense has been allocated to the various categories of operating costs and expenses in a manner similar to the allocation of payroll expense. The Black-Scholes valuation model utilizes inputs that are subject to change over time, including the volatility of the market price of our common stock, risk free interest rates, requisite service periods and assumptions made by us regarding the assumed life and vesting of stock options and stock-based awards. As new options or stock-based awards are granted, additional non-cash compensation expense will be recorded by us. 24 -------------------------------------------------------------------------------- Income Taxes: We account for income taxes using the asset and liability method. Under the asset and liability method, deferred tax assets and liabilities are recognized for the future consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. We maintain valuation allowances where it is more likely than not that all or a portion of a deferred tax asset will not be realized. Changes in valuation allowances are included in our income tax provision in the period of change. In determining whether a valuation allowance is warranted, we evaluate factors such as prior earnings history, expected future earnings and our ability to carry back reversing items within two years to offset income taxes previously paid. To the extent that we have the ability to carry back current period taxable losses to offset income taxes previously paid, we record an income tax receivable and a current income tax benefit. Recent Accounting Pronouncements There were no new accounting pronouncements issued during the nine months ended May 31, 2011 and through the date of this report that we believe are applicable to or would have a material impact on the financial statements of the Company. FORWARD-LOOKING STATEMENTS With the exception of historical facts, the statements contained in "Management's Discussion and Analysis of Financial Condition and Results of Operations" and other parts of this quarterly report on Form 10-Q are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, which reflect our current expectations and beliefs regarding our future results of operations, performance and achievements. These statements are subject to risks and uncertainties and are based upon assumptions and beliefs that may or may not materialize. These forward-looking statements include, but are not limited to, statements concerning: · our belief about the market opportunities for our products; · our anticipated financial performance and business plan; · our expectations regarding the commercialization of, and the potential revenue from, the BSD-2000, BSD 500 and MicroThermX® systems; · our expectations to further expand our developments to treat other forms of cancer and other diseases and medical conditions; · our expectations that we will continue to incur expenses related to seeking governmental and regulatory approvals for our products; · our belief that the MicroThermX® will be a major part of our business plan moving forward and that the growth in our revenues and our ultimate profitability will be largely dependent on the success of our MicroThermX® marketing and sales efforts; 25-------------------------------------------------------------------------------- · our expectations regarding the manufacturing, marketing, distribution, roll out and revenues for the MicroThermX® and the estimated timing thereof; · our expectations that the disposable antenna to be used in conjunction with the MicroThermX® represents a significant ongoing revenue stream; · our belief that the increased number of clinical evaluations will result in sales of the MicroThermX®; · our expectations that additional international shipments of the MicroThermX® and supplies of disposable antennas will occur later in calendar year 2011; · our intentions to continue to devote substantial sums to research and development; · our belief that the level of our operating expenses, including selling, general and administrative expenses, will increase; · our belief that our operating results, revenue and operating expenses may fluctuate in the future from year to year as well as from quarter to quarter; and · our belief that our current cash and cash equivalents will be sufficient to finance our operations for the next twelve months. We wish to caution readers that the forward-looking statements and our operating results are subject to various risks and uncertainties that could cause our actual results and outcomes to differ materially from those discussed or anticipated, including the factors set forth in Item 1A - "Risk Factors" in our Annual Report on Form 10-K for the year ended August 31, 2010 and our other filings with the Securities and Exchange Commission. We also wish to advise readers not to place any undue reliance on the forward-looking statements contained in this report, which reflect our beliefs and expectations only as of the date of this report. We assume no obligation to update or revise these forward-looking statements to reflect new events or circumstances or any changes in our beliefs or expectations, other than as required by law. |