Form 10-Q for MFIC CORP
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15-May-2007
Quarterly Report
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations
Future Operating Results
This report may contain forward-looking statements that are subject to certain risks and uncertainties including statements relating to the Company's plan to achieve, maintain, and/or increase revenue growth, and/or operating profitability, and to achieve, maintain, and/or increase net operating profitability. Such statements are based on the Company's current expectations and are subject to a number of factors and uncertainties that could cause actual results achieved by the Company to differ materially from those described in the forward-looking statements. The Company cautions investors that there can be no assurance that the actual results or business conditions will not differ materially from those projected or suggested in such forward-looking statements as a result of various factors, including but not limited to, the following risks and uncertainties: (i) whether the performance advantages of the Company's Microfluidizer® materials processing equipment will be realized commercially or that a commercial market for the equipment will continue to develop, (ii) whether the timing of orders will significantly affect quarter to quarter revenues and resulting net income results for a particular quarter, which may cause increased volatility in the Company's stock price, (iii) whether the Company will have access to sufficient working capital through continued and improving cash flow from sales and ongoing borrowing availability, the latter being subject to the Company's ability to maintain compliance with the covenants and terms of the Company's loan agreement with its senior lender, (iv) whether the Company's technology will be adopted by customers as a means of producing MMR (defined below) innovative materials in large quantities, (v) whether the Company is able to deploy prototype MMR placements and then manufacture and introduce commercial production MMR equipment, (vi) whether the Company will achieve a greater proportion of its sales in the future through the sale of advanced processor production systems, and (vii) as well as those risks set forth in Item 1a, "Risk Factors," in the Company's Annual Report on Form 10K for the year ended December 31, 2006. The Company assumes no responsibility to update any forward-looking statements as a result of new information, future events, or otherwise.
Overview
MFIC Corporation ("MFIC" or the "Company") has, for over 20 years, specialized in manufacturing and marketing a broad line of high shear fluid processing systems used in numerous applications in the chemical, pharmaceutical, biotech, food and cosmetics industries.
MFIC's line of high shear fluid processor equipment, marketed under the Company's Microfluidizer trademark and trade name, process premixed formulations to produce small uniform structures, usually of the submicron and nanoscale size
(commonly defined as particles having dimensions less than 100 nanometers)
including nanostructures, microemulsions and nanosuspensions. The equipment produces commercial quantities of such materials important to producers of pharmaceuticals, coatings and other products. Further, the Company guarantees scaleup of formulations and results on its processor equipment from 10 milliliters per minute on its laboratory and bench top models to more than 15 gallons per minute on its pilot and production models.
The Company's technology embodied within its Microfluidizer high shear fluid processor is used for formulation of products that are normally very difficult to mix and stabilize. Microfluidizer processors through process intensification allow manufacturers in the chemical, pharmaceutical, cosmetic, and food processing industries to produce higher quality products with better characteristics on a more consistent basis than with other blending, mixing or homogenizing techniques. Additionally, the equipment is used for cell disruption to harvest the cultivated contents of bacterial, yeast, mammalian and/or plant cells and for liposomal encapsulation of materials for the cosmetics and biotech/biopharma industries.
The Company has begun to take steps toward commercializing its proprietary equipment, processes and technology for the continuous production of precipitated submicron or nanoscale particles by interaction of discrete streams of reacting materials, through a novel adaptation of its Microfluidizer processor equipment that permits the mixing of, and reactions between, streams of different solutions at high pressures. The Company refers to this technology as a Multiple Stream High Pressure Mixer/Reactor or Microfluidics Reaction technology (MMR). In August 1997, the Company filed a patent application for the device and its processes with the United States Patent and Trademark Office (USPTO), and filed a Patent Cooperation Treaty (PCT) application on May 5, 1998. In July and November 2000, the USPTO issued to the Company notices of allowances of utility patent claims regarding the MMR and the use thereof. On September 18, 2002, the European Patent Office advised the Company it would grant its MMR patent substantially as applied for, including its device and process claims. The Company has gained national entry of the patent in France, Germany, Italy, The Netherlands, and the United Kingdom. The Company is still prosecuting the allowance of the patent in Canada. The Company's management believes that future commercialization and growth of nanotechnology may be, in large part, enabled by the manufacturing capability of the Company's materials processor and MMR equipment.
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The Company was incorporated in Delaware in 1983. The Company, formerly named Biotechnology Development Corporation, changed its name effective June 8, 1993 to Microfluidics International Corporation, and again changed its name effective July 12, 1999 to MFIC Corporation. From August, 1998 until its sale on February 9, 2004, the Company also operated another division, known as the Morehouse-COWLES Division, which manufactured and sold a broad line of mechanical fluid materials processing systems used for a variety of dispersing, milling, and mixing applications across a variety of industries. The Company's principal executive offices are located at 30 Ossipee Road, in Newton, Massachusetts 02464-9101 and its telephone number is (617) 969-5452.
Critical Accounting Policies
Our significant accounting policies are summarized in Note 1 to our consolidated financial statements included in Item 8 of our Annual Report on Form 10-K for the period ended December 31, 2006. However, certain of our accounting policies require the application of significant judgment by our management, and such judgments are reflected in the amounts reported in our consolidated financial statements. In applying these policies, our management uses its judgment to determine the appropriate assumptions to be used in the determination of estimates. Those estimates are based on our historical experience, terms of existing contracts, our observance of market trends, information provided by our strategic partners and information available from other outside sources, as appropriate. Actual results may differ significantly from the estimates contained in our consolidated financial statements. There has been no change to our critical accounting policies through the quarter ended March 31, 2007. Our critical accounting policies are as follows:
† Revenue Recognition. The Company recognizes revenue in accordance with Staff Accounting Bulletin ("SAB") No. 104, "Revenue Recognition in Financial Statements." The Company recognizes revenue from product sales upon shipment, provided that a purchase order has been received or a contract has been executed, there are no uncertainties regarding customer acceptance, the sales price is fixed or determinable and collection is deemed probable. If uncertainties regarding customer acceptance exist, the Company recognizes revenue when those uncertainties are resolved and title has been transferred to the customer. Amounts collected or billed prior to satisfying the above revenue recognition criteria are recorded as deferred revenue.
† Accounts Receivable Valuation. We perform various analyses to evaluate accounts receivable balances and record an allowance for bad debts based on the estimated collectibility of the accounts such that the amounts reflect estimated net realizable value. If actual uncollectible amounts significantly exceed the estimated allowance, the Company's operating results would be significantly and adversely affected.
† Inventory Valuation. We value our inventory at the lower of our actual cost or the current estimated market value. We regularly review inventory quantities on hand and inventory commitments with suppliers and record a provision for excess and obsolete inventory based primarily on our historical usage for the prior twenty-four month period. Although we make every effort to ensure the accuracy of our forecasts of future product demand, any significant unanticipated change in demand or technological developments could have a significant impact on the value of our inventory and our reported operating results.
† Product Warranties. Our products are generally sold with a twelve month warranty provision that requires us to remedy deficiencies in quality or performance of our products at no cost to our customers only after it has been determined that the cause of the deficiency is not due to the actions of the machine operator or product used in the machine. The Company has established a policy for replacing parts that wear out or break prematurely. The policy called for replacing the parts or repairing a machine within one year of the sale. Commencing in May of 2006, the Company altered its warranty by limiting to a period of 90 days its warranty coverage on certain critical wear items. The Company is now selling more advanced processor production systems than past years that may require more costly parts. As of March 31, 2007 the Company has a reserve balance for product warranties in the approximate amount of $76,000, which we believe is adequate.
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Results of Operations
Three Months Ended March 31, 2007 vs. March 31, 2006
Revenues
Total revenues for the three months ended March 31, 2007 were approximately $2,801,000, as compared to revenues of $3,151,000 for the comparable prior year period, a decrease of approximately $350,000, or 11.1%.
North American sales for the three months ended March 31, 2007 increased to approximately $1,707,000, a 14.6% increase, as compared to sales of approximately $1,489,000 for the three months ended March 31, 2006. The increase in North American sales was principally due to an increase in the sale of machines of approximately $129,000 and an increase in the sale of spare parts of approximately $89,000. Foreign sales were approximately $1,094,000 for the three months ended March 31, 2007, compared to $1,662,000 for the three months ended March 31, 2006, a decrease of $568,000, or 34.2%. The decrease in foreign sales was principally due to a decrease in the sale of machines of approximately $295,000 and a decrease in the sale of spare parts of approximately $273,000. The overall decrease in sales was principally due to the delay in shipment of two (2) production units and four (4) smaller units until the second quarter of fiscal 2007. The total value of these units represent approximately $820,000 in sales.
Cost of Goods Sold
Cost of goods sold for the three months ended March 31, 2007 was approximately $1,194,000, or 42.6% of revenue, compared to $1,447,000, or 45.9% of revenue, for the comparable prior year period. The decrease in cost of goods sold in absolute dollars for the three months ended March 31, 2007, reflects the decrease in sales. The Company's major product lines have different profit margins, as well as multiple profit margins within each product line. The decrease in cost of goods sold as a percentage of sales is primarily attributable to i) the delay in the shipment of two (2) production units having a lower gross profit margin than laboratory units, ii) a decrease in sales to our distributor in Japan who purchases machines and spare parts from the Company at a discount, and iii) an increase in the average sales price per unit compared to the three months ended March 31, 2006.
Research and Development Expenses
Research and development expenses for the three months ended March 31, 2007 were approximately $536,000, compared to $397,000 for the comparable prior year period, an increase of approximately $139,000, or 35.0%. The increase in research and development expenses was primarily due to planned increases in payroll and related costs of approximately $69,000, and development costs related to product enhancements of approximately $56,000.
Selling Expenses
Selling expenses for the three months ended March 31, 2007 were approximately $824,000, compared to $616,000 for the comparable prior year period, an increase of $208,000, or 33.8%. The increase is primarily attributable to a planned increase in payroll and related costs of approximately $95,000, an increase in commission expense of approximately $49,000 resulting from higher North American and European sales of products having higher commission rates, and an increase in occupancy costs of approximately $21,000.
General and Administrative Expenses
General and administrative expenses for the three months ended March 31, 2007, were approximately $677,000, compared to $622,000 for the comparable prior year period, an increase of $55,000, or 8.8%. The increase in general and administrative expenses is principally due to i) an increase in consultant costs primarily related to compliance with Sarbanes Oxley of approximately $44,000,
ii) an increase in planned payroll and related costs of approximately $27,000, and iii) an increase in public relations costs of approximately $17,000. These increases were partially offset by a decrease in professional fees of approximately $38,000 due primarily to the absence of costs related to filing of a registration statement which were incurred during the three months ended March 31, 2006.
Interest Income and Expense
Interest expense for the three months ended March 31, 2007 was approximately $8,000 compared to $9,000 for the comparable prior year period, a decrease of approximately $1,000 or 11.1%.
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Interest income for the three months ended March 31, 2007 was approximately $21,000 compared to $10,000 for the comparable prior year period, an increase of $11,000 or 110.0%. The increase is due to an increase in cash available for investment, principally from the collection of trade receivables.
Income Tax Provision
For the three months ended March 31, 2007, the Company recognized no tax provision due to the loss from operations. For the three months ended March 31, 2006, the Company recognized a tax provision of $27,000 at the Company's expected annualized effective tax rate of approximately 40%.
Liquidity and Capital Resources
As of March 31, 2007, the Company had approximately $1,956,000 in cash and cash equivalents, compared to $1,860,000 as of December 31, 2006. The Company generated cash of $129,000 and $72,000 from operations for the three months ended March 31, 2007 and 2006, respectively. For the three months ended March 31, 2007, the Company generated cash by a decrease in trade accounts receivables, partially offset by the loss from operations, an increase in inventories, prepaid expenses and other assets, and a decrease in current liabilities. The increase in inventories was primarily a result of the delay in shipment of the previously discussed units. For the three months ended March 31, 2006, the Company's principal operating cash requirements were to fund its increase in inventory due to production requirements for orders, other prepaid and current assets; offset by its income from operations, decrease in current liabilities, and a decrease in trade receivables.
The Company used cash of $22,000 and $14,000 for investing activities for the three months ended March 31, 2007 and 2006, respectively. Net cash used by investing activities for the three months ended March 31, 2007 and 2006 were for the purchase of capital equipment.
The Company used cash of $11,000 and $44,000 for financing activities for the three months ended March 31, 2007 and 2006, respectively. Net cash used for financing activities for the three months ended March 31, 2007 and 2006 were for principal payments on the term loan and capital equipment loans, partially offset by proceeds from the issuance of common stock for options exercised and proceeds from stock issued from the employee stock purchase plan.
As of March 31, 2007, the Company maintains a revolving credit and term loan agreement (the "Credit Facility") with Banknorth, N.A., providing the Company with a $1,000,000, four-year revolving credit line and a $1,000,000 four-year term loan facility. As of March 31, 2007, there was no balance due under its revolving credit line and a balance of $250,000 under its term loan facility.
The Company's contractual obligations as of March 31, 2007 are as follows:
Total as of Payable During Payable Payable
(in thousands) March 31, 2007 Remainder of 2007 in 2008 in 2009
Term note $ 250 $ 188 $ 62 $ -
Operating leases 1,147 313 417 417
Capital leases 10 7 3 -
$ 1,407 $ 508 $ 482 $ 417
Assuming that there is no significant change in the Company's business, the Company believes that cash flows from operations, together with the Credit Facility, and the existing cash balances, will be sufficient to meet its working capital requirements for at least the next twelve months.
