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AETRIUM INC - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) The following discussion and analysis should be read in conjunction with our unaudited condensed consolidated financial statements, and the notes thereto, and other financial information appearing elsewhere in this Quarterly Report on Form 10-Q and the audited consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2013. All figures in the following discussion are presented on a consolidated basis. All dollar amounts and percentages presented herein have been rounded to approximate values. Forward-Looking Statements The following management's discussion and analysis includes "forward-looking statements", as such term is used within the meaning of the Private Securities Litigation Reform Act of 1995. These "forward-looking statements" are not based on historical fact and involve assessments of certain risks, developments, and uncertainties in our business looking to the future. Such forward-looking statements can be identified by the use of terminology such as "may", "will", "should", "expect", "anticipate", "estimate", "intend", "continue", or "believe", or the negatives or other variations of these terms or comparable terminology. Forward-looking statements may include projections, forecasts, or estimates of future performance and developments. Forward-looking statements contained in this Quarterly Report on Form 10-Q are based upon assumptions and assessments that we believe to be reasonable as of the date of this Quarterly Report on Form 10-Q. Whether those assumptions and assessments will be realized will be determined by future factors, developments, and events, which are difficult to predict and may be beyond our control. Actual results, factors, developments, and events may differ materially from those we assumed and assessed. Risks, uncertainties, contingencies, and developments, including those discussed in this Management's Discussion and Analysis of Financial Condition and Results of Operations and those identified in "Risk Factors" in Item 1A herein, in our Quarterly Report on Form 10-Q for the period ended March 31, 2014 and in our Annual Report on Form 10-K for the fiscal year ended December 31, 2013, could cause our future operating results to differ materially from those set forth in any forward-looking statement. There can be no assurance that any such forward-looking statement, projection, forecast or estimate contained can be realized or that actual returns, results, or business prospects will not differ materially from those set forth in any forward-looking statement. Given these uncertainties, readers are cautioned not to place undue reliance on such forward-looking statements. We disclaim any obligation to update any such factors or to publicly announce the results of any revisions to any of the forward-looking statements contained herein to reflect future results, events or developments. Overview Recent Developments Prior to April 2014, Aetrium was a manufacturer of a variety of equipment used in the semiconductor industry. In July 2013, we sold the assets related to our reliability test ("RTP") line of products to Cascade Microtech, Inc., a semiconductor equipment manufacturer based in Beaverton, Oregon ("Cascade"), and in April 2014, we transferred our test handler product line to Boston Semi Automation LLC, a semiconductor equipment company based in Boston, Massachusetts ("BSA"). Also in April 2014, we acquired a manufacturer of modular housing units for commercial and residential applications based in South Paris, Maine ("KBS"). Following these transactions, KBS represents Aetrium's sole operating business. Operating results related to the RTP and test handler product lines have been reclassified and presented as discontinued operations for all periods presented. Unless otherwise indicated, the following management discussion and analysis refers to continuing operations only, since comparison to prior periods would not be meaningful. 3 KBS KBS is a New England-based manufacturer of modular buildings. KBS was founded in 2001 as a builder of modular homes. In 2008, KBS began building modular multi-family housing units. In subsequent years, KBS expanded its product offerings to include a variety of commercial buildings including apartments, condominiums, townhouses, dormitories, hospitals, office buildings and other structures. The buildings are manufactured in two production facilities, located in South Paris and Waterford, Maine. The structures are designed to be built inside our factories and transported to the site where they are set and secured on the foundation. Electrical, plumbing, and HVAC systems are inspected and tested in the factory, prior to transportation to the site, to ensure the building meets all local codes and quality requirements. Modular construction has gained increased acceptance and is a preferred method of building by many architects and general contractors. The advantages of modular construction include: modules are constructed in a climate-controlled environment; weather conditions do not interrupt or delay construction; the building is protected from weather, reducing the risk of mold due to materials absorbing moisture from rain or snow; reduced site work; reduced vandalism and attrition, as the building is immediately secured; and a significant reduction in overall project time. Although modular construction in our factories eliminates many of the weather-related challenges encountered with site-built construction, KBS's operations can be impacted by weather and other seasonal factors. Weather can cause delays in site preparation, including delays in building the foundation for a commercial project or single family home. Additionally, sales demand, especially for single family homes, generally weakens in the winter months. As a result, KBS experiences some seasonality, with the July through September quarter typically being the strongest demand period and the January through March quarter typically being the lowest demand period during the year. The KBS strategy is to offer top quality products for both commercial and residential buildings with a focus on customization to suit the project requirements. Our production strategy is to maintain and grow the resources necessary to build a variety of commercial and residential buildings. We attempt to utilize the most efficient methods of manufacturing and high quality materials in all of our projects. Our sales team works to attract new architects and contractors in New England who need the flexibility that KBS offers. Our competitive strategy is to offer a superior product unique to the project's requirements, provide value with our engineering and design expertise, and provide the product in the timeframe needed by the customer. KBS's customers include builders, general contractors and owners of commercial buildings. Prior to our acquisition of KBS, it operated under a March fiscal year. Based on unaudited information, KBS sales to its top three customers in its fiscal year ended March 2014 accounted for 41% of total net sales and sales to its top two customers in its fiscal year ended March 2013 accounted for 26% of total net sales, which amounts included sales to one customer that represented 15% of total net sales in each fiscal year. In the past two fiscal years, approximately 60% of total sales were for commercial properties and 40% were for single family homes. KBS homes are sold by a network of non-exclusive dealers and contractors in New England. Many of these dealers and contractors have KBS model homes on display at their retail centers. We attend the Architecture Boston Expo (ABX) trade show in October each year. In addition, we employ four direct sales people that work with existing contractors and solicit business from new architects and general contractors. Many projects come to KBS from unsolicited requests by architects and general contractors. As of June 30, 2014, KBS had 201 employees. KBS owns two facilities which were included in the assets acquired by Aetrium. KBS conducts administration, sales, marketing, engineering and manufacturing activities at its primary facility located in South Paris, Maine, which consists of approximately 90,000 square feet. It conducts manufacturing activities at its second facility which is located nearby in Waterford, Maine and consists of approximately 60,000 square feet. 4 Critical Accounting Policies Aetrium's critical accounting policies are disclosed in our most recent Annual Report on Form 10-K for the year ended December 31, 2013 and Note 2 to our unaudited interim condensed consolidated financial statements. As a result of our acquisition of KBS and the divestiture of our test handler product line as described above, the following critical accounting policies were modified during the quarter ended June 30, 2014 as follows: Revenue Recognition: Commercial projects, which include multi-unit residential buildings such as apartment buildings, condominiums, townhouses, and dormitories as well as commercial structures such as hospitals and office buildings are manufactured to customer specifications and may take up to several months to complete. Some commercial contracts provide that we perform services at the customer's site to complete a project, including electrical, plumbing, heating and air conditioning services ("site work") and some contracts provide that we only manufacture, deliver and set the modular units on the foundation, in which cases the site work is performed by others. Except for a small number of homes we sell directly, contracts for single family homes do not include site work, which is performed by independent builders, and the homes are generally delivered and set on the foundation within a few days after being manufactured. For commercial and single family home contracts, we recognize revenue under the percentage of completion method based on a units-of-production method. Units-of-production are defined as modules delivered and set on the foundation as well as site work progress approved by the project owner. The current asset "Costs and estimated profit in excess of billings" represents revenues recognized in excess of amounts billed and the current liability "Billings in excess of costs and estimated profit" represents billings in excess of revenues recognized. Application of the percentage of completion method of accounting requires the use of estimates of costs to be incurred in completing our performance under a contract. The cost estimating process is based on the knowledge and experience of management and involves making significant judgments. Changes in contract performance, change orders, estimated profitability, final contract settlements and other factors may result in changes to estimated and actual costs and profit. The effects of such changes are recognized in the period in which the revisions are determined. Goodwill and Intangible Assets: Goodwill and other indefinite-lived intangible assets are assessed annually in order to determine whether their carrying value exceeds their fair value. In addition, they are tested on an interim basis if an event occurs or circumstances change between annual tests that would more likely than not reduce their fair value below carrying value. If we determine the fair value of goodwill or other indefinite-lived intangible assets is less than their carrying value as a result of the tests, an impairment loss is recognized. Impairment losses, if any, are reflected in operating income or loss in the period incurred. We review finite-lived intangible assets for impairment whenever an event occurs or circumstances change which indicates that the carrying amount of such assets may not be fully recoverable. Recoverability is determined based on an estimate of undiscounted future cash flows resulting from the use of an asset and its eventual disposition. An impairment loss is measured by comparing the fair value of the asset to its carrying value. If we determine the fair value of an asset is less than the carrying value, an impairment loss is incurred. Impairment losses, if any, are reflected in operating income or loss in the consolidated statements of operations during the period incurred. Valuations and impairment assessments related to goodwill and other intangible assets involve significant judgments and estimates. Actual results could differ from those estimates and such differences may be material to our financial statements. 5 Results of Operations Net Sales. Net sales from continuing operations for the three and six months ended June 30, 2014 were $11.4 million, compared with zero for the same periods in 2013, as we have divested our operating business owned in the prior year. Sales of commercial structures and single family homes represented approximately 63% and 37% of total net sales, respectively, in the three and six months ended June 30, 2014. Cost of Sales. Cost of sales amounted to $10.4 million for the three and six months ended June 30, 2014, compared with zero for the same periods in 2013 as we have divested our operating business owned in the prior year. Selling, General and Administrative. Selling, general and administrative ("SG&A") expenses for the six months ended June 30, 2014 were $3.0 million compared with $1.5 million for the comparable period in 2013, an increase of $1.5 million. Approximately $1.1 million of the increase was attributable to our acquisition of KBS on April 2, 2014, including $0.7 million of KBS operating expenses and $0.4 million of amortization expense related to the acquired intangible assets. In addition, our expenses for professional services increased approximately $0.6 million over the same period in the prior year primarily due to costs associated with the acquisition of KBS and the divestiture of our test handler product line. SG&A expenses for the three months ended June 30, 2014 were $2.2 million compared with $0.8 million for the comparable period in 2013, an increase of $1.4 million. Approximately $1.1 million of the increase was attributable to our acquisition of KBS, including $0.7 million of KBS operating expenses and $0.4 million of amortization expense related to the acquired intangible assets. The remaining increase consisted of approximately $0.5 million for professional services related to the acquisition of KBS and the divestiture of our test handler product line, partially offset by approximately $0.1 million of sublease income. Change in Fair Value of Contingent Earn-Out. Change in fair value of contingent earn-out of $0.1 million for the six month period ended June 30, 2014 represented an increase in the fair value of the earn-out receivable related to the sale of our RTP line of products. The increase in the earn-out receivable was based on reassessments of its fair value at March 31, 2014 and June 30, 2014 and resulted from our analysis of updated revenue information reported to us by the purchaser of the business and final settlement of this contingency. Interest Expense, Interest Income. Interest expense amounted to $0.2 million for the three and six months ended June 30, 2014 and consisted of interest related to the debt we incurred in connection with the KBS acquisition in April 2014 as described in Note 8 to our condensed consolidated financial statements. Interest income for all periods presented and interest expense for the three and six months ended June 30, 2013 were not significant. Income Taxes. Since 2009, we have maintained a valuation allowance to fully reserve our deferred tax assets. We expect to continue to maintain a full valuation allowance until we determine that we can sustain a level of profitability that demonstrates our ability to realize these assets. To the extent we determine that the realization of some or all of these benefits is more likely than not based upon expected future taxable income, a portion or all of the valuation allowance will be reversed. Such a reversal would be recorded as an income tax benefit and, for some portion related to deductions for stock option exercises, an increase in shareholders' equity. We recorded no income tax expense or benefit for the three and six month periods ended June 30, 2014 and 2013. The income tax expense attributed to discontinued operations for the three and six month periods ended June 30, 2014, calculated using a 35% marginal tax rate, is offset by a corresponding income tax benefit for continuing operations. 6 Discontinued Operations. As discussed in Note 4 to our condensed consolidated financial statements, in July 2013 we sold the assets related to our RTP line of products to Cascade and in April 2014 we transferred our test handler product line to BSA. In accordance with ASC 205-20, "Discontinued Operations," results related to RTP and test handler operations have been reclassified and presented as discontinued operations for all periods reported. Condensed results of discontinued operations are summarized below (in thousands): Three months ended Six months ended June 30, June 30, 2014 2013 2014 2013 Net sales $ 218 $ 1,104 $ 2,376 $ 2,391 Costs and expenses; Cost of sales 150 1,433 1,400 1,927 Operating expenses 369 809 779 1,679 Total costs and expenses 549 2,233 2,179 3,606 Income (loss) from discontinued operations (301 ) (1,138 ) 197 (1,215 ) Gain on sale of discontinued operations 1,128 - 1,128 - Income (loss) before income taxes 827 (1,138 ) 1,325 (1,215 ) Income tax expense (290 ) - (464 ) - Income (loss) from discontinued operations $ 537 $ (1,138 ) $ 861 $ (1,215 ) Financial Condition, Liquidity and Capital Resources Cash and cash equivalents decreased by approximately $0.1 million in the six months ended June 30, 2014. Cash flows used in operating activities. In the six months ended June 30, 2014, cash flows used in operating activities were $1.0 million, consisting primarily of our net loss of $2.0 million (excluding a $1.1 million pre-tax gain on the sale of our test handler product line), partially offset by $0.5 million in non-cash depreciation and amortization expense and approximately $0.6 million in working capital changes. Working capital changes generating cash included a decrease of $1.2 million in inventories and increases of $0.2 million in accounts payable and $0.7 million in other accrued liabilities, partially offset by a $1.6 million increase in accounts receivable. The decrease in inventories was primarily attributed to the sale of seven VMAX test handlers prior to the transfer of our test handler product line to BSA in April 2014. The increase in other accrued liabilities included increases of $0.3 million in accrued facility expenses, $0.2 million in accrued sales taxes and $0.2 million in accrued interest expense. The increase in accounts receivable included a $1.9 million increase in receivables at our KBS operations since the April 2014 acquisition date which was related solely to the timing of collections as approximately $2.3 million was collected on July 1, 2014. In the six months ended June 30, 2013, cash flows used in operating activities were $1.5 million, including our net loss of $2.8 million, partially offset by $1.0 million in non-cash expenses and $0.2 million in working capital changes. Non-cash expenses for this period included a $0.8 million charge for excess and obsolete inventories and share-based compensation expense of $0.2 million. Working capital changes generating cash consisted primarily of a $0.3 million increase in accounts payable, primarily reflecting high legal billings related to litigation in the second quarter of 2013, partially offset by a $0.1 million increase in accounts receivable. Cash flows used in investing activities. In the six months ended June 30, 2014, cash flows used in investing activities were approximately $4.2 million, which consisted of the $4.6 million net cash portion of the purchase price paid in connection with our acquisition of KBS ($5.0 million paid at closing less $0.4 million of cash acquired), partially offset by approximately $0.4 million received in final settlement of the contingent earn-out in connection with our sale of our RTP product line to Cascade. Cash flows used in investing activities in the six months ended June 30, 2013 were not significant. 7 Cash flows provided by financing activities. In the six months ended June 30, 2014, cash flows provided by financing activities were approximately $5.1 million, which consisted primarily of the $6.5 million in financing received from the sale of promissory notes as discussed below, less $1.4 million of KBS debt that was assumed and paid at the closing of the KBS transaction. Cash flows used in financing activities in the six months ended June 30, 2013 were not significant. In connection with the KBS acquisition, on April 1, 2014, we entered into a Securities Purchase Agreement with Lone Star Value Investors, LP ("LSVI") pursuant to which LSVI purchased for $6.5 million in cash, an unsecured promissory note made by Aetrium in the principal amount of $6.0 million (the "LSVI Promissory Note"), bearing interest at 10.0% per annum, with interest payable semiannually and any unpaid principal and interest due on April 1, 2019, and an unsecured convertible promissory note made by Aetrium in the principal amount of $0.5 million (the "LSVI Convertible Promissory Note"), bearing interest at 5.0% per annum, with interest payable semiannually and any unpaid principal and interest due on April 1, 2019. At any time after July 30, 2014, at LSVI's option, the unpaid principal amount of the LSVI Convertible Promissory Note may be converted into shares of our common stock at $4.66 per share, the consolidated closing bid price of our shares on the Nasdaq Capital Market on the trading date immediately preceding the date the note was issued. We may prepay these notes at any time after a specified amount of advance notice to LSVI. On April 2, 2014, as partial consideration for the KBS acquisition, our wholly-owned subsidiary KBS Builders issued to KBS an unsecured promissory note in the principal amount of $5.5 million, bearing interest at 4.0% per annum with all principal and interest due on October 1, 2014 (the "KBS Note"). On July 21, 2014, we entered into a Securities Purchase Agreement with Lone Star Value Co-Invest I, LP ("LSV Co-Invest") pursuant to which LSV Co-Invest purchased, for $2.5 million in cash, an unsecured promissory note made by Aetrium in the principal amount of $2.5 million (the "LSV Co-Invest Note"), bearing interest at 10.0% per annum, with interest payable semiannually and any unpaid principal and interest due on April 1, 2019. Except for the principal amount, the terms of the LSV Co-Invest Note are identical to the terms of the LSVI Promissory Note. The note was issued in order to provide additional working capital to Aetrium. Historically, we have supported our capital expenditure and working capital needs with cash generated from operations, debt financings and our existing cash and cash equivalents. In recent years, we have incurred significant losses that have been primarily attributed to the operations of our test handler product line and significant legal expenses related to litigation. Since July of 2013, we implemented several strategic initiatives intended to stabilize the Company and return us to profitability, including the sales of our RTP product line in July 2013 and our test handler product line in April 2014. We acquired KBS, a business that manufactures modular housing units for commercial and residential applications, in April 2014 because we believe there is significant growth opportunity within the industry and it provides Aetrium with the potential to return to profitability. However, there can be no assurance that the acquisition of KBS will lead to sufficient revenue in the future to cover our expenses and allow us to achieve profitability, on a consistent basis or at all. We believe our cash balance on hand ($1.2 million at June 30, 2014), cash flows expected to be generated from operations and/or future financings will be sufficient to meet our net cash requirements for at least the next 12 months, which include but are not limited to payment of the $5.5 million principal amount and accrued interest under the KBS Note ($55,000 as of June 30, 2014) due on October 1, 2014. We are pursuing new financing to replace the $5.5 million KBS Note and to provide for our general working capital needs. However, there can be no assurance that our existing cash reserves, together with funds generated by our operations and any future financings, will be sufficient to meet our net cash requirements. In addition, in order to execute our long-term growth strategy, which may include additional acquisitions, we may need to raise additional funds through public or private equity offerings, debt financings, or other means. 8 |